It was during the rough bear market of the 1930s that market technicians honed their craft and largely built the foundation of knowledge for the field. Their work has been expanded over the years, but the original tenets stand out in their clarity and practicality.
As the worst bear market since the Great Depression has decimated long-term investors’ hopes and dreams, technical analysis is once again proving that many classical techniques defined by that earlier generation hold up during the current environment.
After the crash of 2000, market veteran Ralph Acampora, CMT, noted that technical analysts were about to enter a golden age, when the tools on which they relied would help them outperform buy-and-hold investors. Now the director of Technical Analysis Studies at the New York Institute of Finance, Acampora continues to believe that a basic knowledge of technical analysis is important for anyone seeking to gain from the stock market.
A 19TH CENTURY TOOL
Acampora is a proponent of Dow Theory, a tool that has withstood the test of time. It has provided reliablesignals for more than 100 years, and he has been following them for more than 40. The rules of basic Dow Theory can be entirely written on one side of an index card:
• It uses the closing prices from only two indexes: the Dow Jones Industrial Average and the Dow Jones Transportation Average.
• The two averages must confirm each other’s direction.
• The primary trend of the market is based on the most recent confirmed signal from both averages.
Dow Theory worked well at the turn of this century, and investors would have missed the bulk of the damage from the bear market that followed the dot-com bubble. Both averages fell to lower lows in March 2000, and Acampora was able to correctly warn investors of a major bear market at that time. To Acampora, this shows the value of sticking with the original rules.
Charles Dow developed his indexes to forecast the economy, and because stock prices discount the future, they trade higher or lower based on the economic cycle. The market said that the economy was in trouble even as the NASDAQ reached new highs and investors were forced to learn the harsh lesson that there was no such thing as a new economic paradigm.
A primary bull market signal followed in April-May 2003, about six months after the bottom. Although the market had already increased by about 20 percent at that time, investors who were not able to buy at the exact bottom and waited for the confirmed signal still enjoyed gains of more than 50 percent.
The next sell signal occurred in November 2007, according to Acampora’s analysis, and in late May 2009, that signal remains in force. Acampora looks for one of the averages to show some strength at a true bottom, what...