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Getting
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The
Relationship Between Price and Time is Linear
One of the hardest concepts to grasp is that the
relationship between price and time is linear. That is, the longer price
fails to be behave as anticipated, the more likely we are to amend our
perception of fair value.
The most simple example of this phenomena
involves our ability to take losses. Most investors do not like losses. When they buy a stock
"wrong", they will often attempt to get out of that position without
suffering a loss but as days turn into weeks and weeks turn into months our stubbornness
takes a back seat to common sense. A rationalization process begins and
slowly the perception of what is a suitable exit level is changed (obviously we
will not "sit" on bad stock forever) . This is the linear relationship between time
and price
-- the longer the time frame stretches, the more elastic price expectations
become.
Consider the case of sport and footwear maker
Timberland (TBL).
fig. 1c
For a long time it seemed that Timberland
(TBL) was a firm doing all of the right things. Its clothing and footwear
were a prerequisite for trendy generation X'ers and both sales and profits were
growing at breakneck pace. In anticipation of record earnings the stock
surged to a record high at $72 in the middle of January. After slumping
back to $65 just a few sessions later investors were treated to a strong
earnings report and nothing but good news from corporate executives.
Expansion of the brand was said to be going well in Europe and the future looked
very bright but despite this rosy backdrop the stock could do no better than a
rally to $68 following the earnings. To make matters worse, the stock
closed at the low of the session and gapped a full point lower the following
day. Those that purchased the stock amid all of the good news were trapped
at the virtual record high price on much stronger than average daily
volume. This lead to buyers' remorse (buyers feeling trapped and
now motivated to sell for break-even). Just two weeks later it
looked as though those trapped in the stock from the $68 level would have an opportunity
to exit without a loss but after surging to $66 in a stronger stock market,
sellers immediately began to dump the stock and just two weeks later the stock
was changing hands at $52. With hopes of getting out without a loss now
fleeting, sellers began to sell every significant rally. They did so in
early March, middle April, in late May. In each case they were willing to
take less for their shares. This "sliding scale" caused the
stock to falter all the way to just $37.50 in the middle of
July.
Although the case of Timberland involves
down-trending price characteristics, we need to remember that the same
basic principle applies to stocks moving steadily higher. The longer price
moves away from our predetermined entry level, the more likely we are to
rationalize why we should "chase" price.
Conclusion:
-
The
technical analyst believes that all perceptions of value are encapsulated in one
statistic, price.
-
Despite the protestations of
technical analysis nay-sayers, price is not random, price is determined by
periods of consolidation followed by periods of trending.
-
It is reasonable to expect
that at least some buyers and sellers are informed. These investors
sent trends and in this sense, price has a tendency to precede fundamental
developments.
-
It is human nature to try to
minimize losses when stock positions are purchased "wrong".
Investors will attempt to exit positions without suffering a loss but this
desire diminishes in a linear fashion with the passage of time.
Now that we have a better
understanding of price, let's move-on to another technical analysis basic,
support and resistance.
price
anticipates fundamental changes
support
and resistance
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