Book Review of The Master Trader by Laszlo Birinyi

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Book Review of The Master Trader by Laszlo Birinyi
This Book Review of The Master Trader by Laszlo Birinyi is brought to you by Ben Feldman from the Titans of Investing.

Genre: Non-fiction
Author: Laszlo Birinyi
Book: The Master Trader (Buy the Book)

Executive Summary

The Master Trader, written by renowned money manager Laszlo Birinyi and published in 2013, is a compilation of data analysis and personal trading experience from one of the foremost traders of our time. Birinyi draws upon over 40 years of market knowledge and wisdom to put together a series of vignettes and short essays that offer many pieces of advice to both the novice and the professional trader, alike.

The book is organized into Birinyi’s analysis of different approaches to trading that have been made popular in recent history. Starting with technical analysis, he uses both his extensive trading career, along with in-depth data analysis to conclusively show what works and what falls woefully short of expectations. Before anyone can succeed in the market, he/she must first understand the critical pitfalls and mistakes to avoid.

Knowing that Wall Street is not innocent and that professional money managers can often have conflicting incentives, is an important place to begin. In this light, Birinyi highlights many of the commonly held misconceptions about traders that have held for as long as he can remember. Technical analysis is just one of many ways people have sought to make easy money in the most unforgiving game of all: professional investing.

Birinyi covers trading concepts far beyond technical and fundamental analysis. Market cycles, large gaps in stock price, money flows, anecdotal data, and stock picking all are given a rigorous test against both experience and data. Each method has its own merits, but as you will see, the vast majority of the hype that exists in the market these days is simply that.

Unfortunately for most people, Wall Street always wins.  A more pragmatic way of phrasing that for the vast majority of investors would be that, beating the market is simply not feasible nor a goal one should try to attain. That doesn’t mean that people shouldn’t try. He gives the example of professional golf.

While less than 1% of golfers may actually make the PGA, many millions of golfers go out to the links every day and certainly take much pleasure in doing so.  If you do decide to try to beat the market, the following essays will offer valuable insights into becoming the best investor possible.

Trading Strategies

What does not work?

  • Technical analysis. It is not predictive, it is not consistent, and it is not analysis.
  • Taking the advice of market “gurus.” The Street can be more about marketing than the markets.
  • Fundamental analysis is overrated. Terms like “competence of management” are nebulous.

What does work?

  • Technical analysis can tell you if the market is an “overbought” condition or in an “oversold” condition. Buying the market in both states is profitable.
  • Money flows analyze every single trade in every single stock and is able to provide investors with information regarding future returns. 20% of the market is discounting some event at any given time, and money flows can signal how much information is actually incorporated into the stock price.
  • The ideal investment approach must incorporate data, analysis, and strategy. Data must also include anecdotal data, which provides an accurate understanding of the sentiment of the market.
  • Market cycles produce some of the most tradable insights. The technology and the financial sectors are leading indicators of the overall market.
  • Stocks with “sprained wrists” create great buying opportunities. Look for the short-lived bad news. Heavy selling and an it-can’t-get-any-worse mentality can also create great buying opportunities.


The Master Trader, written by renowned money manager Laszlo Birinyi and published in 2013, is a compilation of data analysis and personal trading experience from one of the foremost traders of our time. The following vignettes come from Birinyi’s own personal experience as well as that of his firm, Birinyi Associates.  

Throughout his tenure of over 40 years, Birinyi has tried or thought through nearly every trading strategy imaginable.  From the Bangladesh butter production strategy, to sound fundamental analysis, Birinyi has the data and reasoning for exactly how to play the game of trading.

It is nearly impossible to turn on your television without hearing market “experts” or “strategists” spouting trading ideas as if everyone knew the secret to the market except for you.  Unfortunately, Wall Street can be more about marketing than the markets.  This brief will discuss how to decipher the seemingly never-ending stream of trading strategies that are being perpetrated by the Wall Street marketing machine.

Technical Analysis

“I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

–Warren Buffett

Technical analysis does not work.  It is not predictive, it is not consistent, and it is not analysis. It is a methodology that attempts to use past market data, primarily price and volume charts, to forecast the future movement of prices. It is a study of the stock market that has been perpetuated largely because people prefer to see charts tables and graphics over pure words on a page.

Perhaps there’s even an embedded level of additional trust that is associated with charts as they represent hard facts in data. Technical analysis, however, is not hard facts and it comes far short of the ostensible goal of making investors money.

The four main reasons why technical analysis fails are:

  1. a lack of real analysis
  2. most analysts don’t understand the market
  3. not recognizing the changing nature of the market, the industry, or the environment,
  4. it is commentary, rather than tangible advice. The following are two examples of how technical analysis has broken down in the past.

Example 1- The Hindenburg Omen- In mid-2010, investors were bombarded by extensive media coverage around a rather obscure conglomerate of technical signals called “The Hindenburg Omen.” It was supposed to be a terrible sign for the stock market and was often accompanied by the word “crash.” A WSJ blog reported not long after the event was supposed to take place “Yep, it was a dud.” The market gained 22% through the rest of the year instead of crashing.

Example 2- The 1987 Market CrashTechnicians have a very disappointing record at critical junctures for the market.  The 1987 Crash marked the end of the Volcker rally, which began in 1982, and led to a 229% gain in the S&P before 1987.  Technical analysts missed both the beginning and the end of the great rally. In fact, their predictions went so awry during this period of time that a piece was published in Barron’s, in 1982, titled “Messing Up the Tea Leaves, Where Technical Analysis Went Wrong.”

The article highlights that despite technical analysts being unanimous in their views of the market going into a steep decline and bottoming out in 1982, the DJIA proceeded to rise over 10% in the coming days on impressive volume and continued to do so for the next five years until the great crash.

It is certainly not enough to give a couple of dispersed examples of the failures of technical analysis and claim that the entire system is a sham.  To this end, many other technical indicators are examined and consequently rejected including: the advance/decline line, volume, moving average convergence/divergence (MACD), and the relative strength index (RSI).

The most damning evidence of the failure of technical analysis can be seen through long term studies tracking the performance of any single indicator. Over 20 signals or indicators were tracked over a 2 year period from March, 2009 to April, 2010. Not even a single indicator approximated the market’s return over that period, with more than half of the indicators actually losing money.

If there is one positive note in the realm, it is that technical analysis is actually quite competent at describing the current state of the market. For instance, it can tell you if the market is in an “overbought” condition or in an “oversold” condition. These conditions are defined by the distance a stock is trading above or below its 200 day moving average. When 80% of stocks in the market are trading below their 200 day moving average the market can be considered “oversold.”

Buying the market in this state has actually returned a median of 14.63% over the last 20 years. Thus, buying when the market is oversold is, not surprisingly, a profitable strategy. What is more surprising is that buying the market when it is overbought is also a profitable strategy.  The lesson to be gleaned from this is that the market is not symmetrical.  In other words, if an indicator suggests higher prices, the reverse of that indicator does not necessarily suggest lower prices.

Wall Street is Not Innocent

“The buyer needs a hundred eyes, the seller not one.”

– George Herbert

Before anyone makes a single trade, it is important to be aware of the environment in which you are competing. Wall Street is not innocent in the sense that the customer’s best interests are not always at the heart of the decision making process.  Hubris is the common denominator amongst the majority of bankers and traders, with many of them considering themselves the masters of the universe.  

Analysts are seldom wrong, but they can, at times, be “early.” Portfolio managers may not outperform the market, but they likely have good “relative” performance versus their peers, and technical analysts will often bury their old forecast with a brand new one.

Even professional investors are not immune to missing the shortcomings regarding market commentary and advice. It has even been suggested that the main business of Wall Street has less to do with the markets and more to do with marketing, with a focus on brands and product placement. When famous money manager Paul Tudor Jones was congratulated for his accurate forecast of the decline of the Japanese market in 1989, he remarked that it was the fourth year in a row he had done so.

One example of some of the gamesmanship and marketing mentioned above comes from the well-established practice of calculating average returns of a portfolio based on a price-weighted basis. Simply put, this method assumes an investor buys one unit, or 100 shares, of all the recommendations.

These types of results do well more often than not because for every $74 stock that loses $4 there will be a $4 stock that goes to $8. Of course, most people wouldn’t be less likely to put a large percentage of their wealth into a $4 stock due to its increased riskiness. While this method of reporting returns may well be commonplace, investors should be aware of its potential underperformance.

Another example of an egregious Wall Street deception was given in a report recommending the purchase of the NASDAQ. The approach in the report generated a buy signal in 1975 and the results were exceptional in the ensuing 28 years. Upon closer inspection of the results, however, it was found that the claims were based on the fact that one had sold at the absolute high before the crash of 1987, when in fact, the strategy produced no such sell signal.

The actual sell signal was produced months after the crash yielding a return of 15.8% versus the claim of 63%. After bringing this error to the company managing the strategy, it was forced to report that “Due to the discovery of some statistical aberrations, the publication of the portfolio’s values has been suspended.”

Admittedly, typographical errors, reporting errors, and fact omissions occur in all walks of life, but investors should be particularly wary of Wall Street and the misaligned incentive structures that are ever prevalent. Agency issues can often arise between money managers and the people who they are managing the money for.

Well recognized financial advisors such as Suze Orman, Morningstar, and Investors Business Daily have all published mistakes in the past decade, and whether intentional or not, common investors need to do their own due diligence even when taking the advice of professionals.

Money Flows: An Indicator that Works

“Money has its own language in poker. The way you use it supplements and qualifies the information your opponents glean from your cards.”

–Herbert Yardley

Despite the fact that many indicators can be compelling, detailed, and occasionally useful, analysis and experience has proven that the majority of indicators ultimately fail the test of producing results. However, there is an abundance of information within the stock market itself.  Even the noise can be information.

Traders have long understood the importance of noise, so much so, that when the NYSE expanded into a third trading area, traders were uncomfortable with the lack of noise. They complained to such an extent that noise had to actually be imported from the main room to the extension. By analyzing every single trade in every single stock, money flows are able to determine the amount and the degree of interest in a stock, a group of stocks, or an index.

The definition of money flows applies to actual purchases and sales within the stock market, which is very different than the flow of funds, which also takes into account monies going to intermediaries. In other words, money that goes into a mutual fund should only be counted as a money flow if the mutual fund proceeds to buy shares of stocks.  

If the money simply remains in cash in the mutual fund, that should not be counted towards this. There are five critical issues to take into account regarding money flows.

  1. The critical issue is divergence between money flows and price movement. Money flows tend to lead price movements, but if the two are coincidental they do not provide any insight.
  2. Weighted price must be used to account for both price and volume of a particular trade.
  3. Every trade in every stock is incorporated. Unlike charts, which are heavily influenced by the last trade of the day, money flows calculations are as much a function of mid-day trading as the close.
  4. Experience has told us that only 20% of the market is discounting some event at any given time, and money flows is the only approach that can determine how much available information is incorporated into the stock price.
  5. Buying on weakness reflects significant and meaningful buyers. This suggests accumulating a large position over time as opposed to a simple retail order that would buy at any time.

Many have rejected the idea of money flows over the years, suggesting that for every buyer there had to be a seller, and thus how could we determine that one was more important than the other? The answer begins with trading experience, but also incorporates whether the stock ticks up or down as a result of the trade. The SEC published a multivolume study in 1971 which analyzed the “Price Impacts of Block Trades.”

The study found conclusively that block trades that traded on upticks originated as purchases, and those trades that traded lower were initiated as sales. The most important finding of the entire study is that money flow appears to provide investors with information regarding future returns. The below chart illustrates block trade and whether the stock had an uptick or a downtick subsequent to the trade.

The Master Trader illustrates block trade and whether the stock had an uptick or a downtick subsequent to the trade.

An example of the use of money flows as a trading strategy can be observed in 1983 during the time when OPEC had just cut oil prices.  The effects on the oil stocks was dramatically negative, yet a closer examination of the actual trading activity showed that every time the stocks dipped there was large accumulation amongst institutional buyers.

This suggested that the real money inflows were actually on the buy side, prompting a gain of over 160% in the energy sector over the next four years as compared to the S&P’s 90%.

Money flows are the only indicator to actually lead the market.  Oscillators have to oscillate, trends have to develop, and advances/declines occur no matter what, but money flows tell us something that is going to happen. Much of accurately interpreting money flow involves listening to the voice of Mr. Market.  

In other words, flows are Mr. Market sharing with us where developments are likely to occur in the future. The concept, in practice, captures the effects of smart money. If you know where the large trades are occurring, if they are a buy or a sell, and with how much ease they take place, then you can accurately predict how the stock will move in the future.

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Anecdotal Data

“It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.”

-Mark Twain

The ideal investment approach should incorporate three elements: data, analysis, and strategy. This is by no means a novel approach, but what is novel is the depth and the type of data that is analyzed.  One piece of data that is often not even included in many trading strategies is anecdotal data, or data from a wide variety of articles, magazines, and other media outlets.  Nothing provides a better understanding of the mood, sentiment, and attitude of the market at any particular moment.

Knowing the position of a story, how long it is, the individuals mentioned in it, and how frequently it comes up, is significantly more instructive than the typical Wall Street sentiment polls. Polls, such as the one published by the American Association of Individual Investors, produces some interesting results, but its poll is based on voluntary participation and is thus biased.  

A much less biased means to observe sentiment in the market arises from collecting and analyzing key stories. Creating and maintaining an anecdotal database is highly valuable, especially one that incorporates the end-of-year stories and publications. Focus on palpable stories, days with large market moves, and lengthy bullish/bearish reports.

The clearer picture of sentiment can be gleaned when you have greater variety in both source and time horizon.

Magazines and newspapers are databases in disguise.  One example can be seen in a 2010 WSJ article which led the Money and Finance section. In a lengthy 23-paragraph piece, technicians sounded that all indicators point to more gains ahead.  Unfortunately, the technicians were totally mistaken and the market was about to enter a 15 point correction. Despite their inaccuracy, the anecdote was of significant value.  

In fact, this overly bullish sentiment ended up being one of the most accurate contrarian indicators we’ve observed in recent time and has led to very profitable returns.  The corollary has also been true, where at the absolute bottom of the market, with amazing precision, technicians have told us to sell. Taking the contrarian position on this as well has proved to be quite profitable.

One last form of anecdotal information, which has been shown to be surprisingly insightful, is magazine covers. The magazine cover approach, which says that if something makes it to the cover, the story is out and the game is over, is not entirely accurate.

In fact, magazine covers can indeed be forward-looking indicators with good predictive capacity.  A June 1995 Forbes cover illustrated “Where have all the Bears gone?” and was meant to signify the difficulty in finding a real pessimist on Wall Street. The market went on to gain another 14% that year.

Be Wary and Always Cut the Deck

“I knew a few people who made money acting on economic forecasts but a good many that had made it from selling on them.”

–Friedrich Hayek

Investing is ultimately no easier than accounting or dentistry, and thus there are no shortcuts, magic pills, or secret sauces.  It is therefore reasonable to expect to have to put in significant time and effort before achieving significant returns.  

In this light, it is important for individual investors not to rely on the whim of a media guru, or the latest Barron’s cover. Individuals who would not buy a used car without consulting Kelley Blue Book or a new book without checking Amazon will still seriously consider buying a stock that was highlighted by Jim Cramer on evening television.

To help avoid this mistake, the concept of economic accountability must be stressed.  While one can listen to and observe market “experts” no money should ever be involved until the source of the idea can be held financially responsible when the idea fails.  

This criterion calls into question many media gurus and self-proclaimed market experts who really have no skin in the game themselves besides their reputation which can change on a whim. This section will point out specific examples of when investors must be particularly wary of the advice they are receiving in order to properly avoid these pitfalls moving forward.

In general, it is not a good habit to give commentary unless you are truly an expert.  One example is when Laszlo Birinyi himself was asked to comment on the fall of the Berlin Wall in 1989.  Despite being born in Eastern Europe and having taken some college courses on the region, Birinyi declined to comment at all.

When questioned why he had nothing to say, he responded that he had no relevant insights as to the political and economic ramifications of the event. “I eat steak but that does not make me a rancher.” This view of not commenting on subjects unless you are a genuine expert does not really hold true for the vast majority of market commentators.

As mentioned earlier, Wall Street can be much more characterized by marketing than markets. Firm strategists are one of the best examples of this phenomenon.  Strategists are typically the most visible and vocal of the Street’s commentators, and are usually thought of as the salesmen or pushers of a firm’s strategy.  

As such, their incentives can often be misaligned with the people who would buy their firm’s products. “I think” should not be a critical component in providing input to fiduciaries, nor are suggestions that the market “could” rise.  Unfortunately, the ultimate failing of most strategists is their utter incompetence in actually improving investment returns.  

This was shown, in 2000, when several brokerage firms established mutual funds based on their own research and managed by the firm’s own strategist. Despite being successful in raising weighty capital for the firm, their investment results so grossly underperformed the S&P that they were closed down shortly afterward.

One particularly troubling example of the importance of checking your sources can be seen in questioning the results of Dr. Jeremy Siegel’s book Stocks for the Long Run. Despite being a seminal book in the subject area, deeper analysis of the results uncovers that very little effort was actually devoted to proving his thesis, including a lack of detailed data and virtually only one chart and one table defending his claim. Pricing of two stocks (Bank of America in 1830, and Neptune Insurance in 1843) is blatantly wrong.

Overall, stocks did outperform, but only by the narrowest of margins, and most investors would have preferred the greatly reduced volatility of bonds to the capriciousness of the stock market.

Knowing the source of the information is just as valuable as the information itself.  Intuitive Surgical traded from $544 to $498 in one day after being downgraded by Citron Research.  Citron cited that the company has “excessive and unjustified marketing claims.” Unfortunately, for short-sellers, the stock proceeded to rebound over the following weeks and actually recovered all of its losses plus another $30 after the company reported strong earnings and a positive outlook.  

As it turns out, Citron Research had been previously sanctioned for “fraudulent communications and attempts to cheat, defraud, or deceive customers,” and has also been sued four times as a result of their postings.

Can You Play like Warren Buffet?

“Like all of life’s rich emotional experiences, the full flavor of losing important money cannot be conveyed by literature.”

–Fred Schwed

When entering the arena of investing, always keep one mantra in the back of your mind: Wall Street Always Wins. Phrased more pragmatically, that should suggest that you can’t beat the market and, more importantly, do not beat yourself up for not doing so.  

All of this should not suggest, however, not to invest. Millions of golfers enjoy the experience of golf even though they are very far away from making the PGA tour.  Before “playing the game” it is important to assess your concept of risk and time horizon.

The hardest question of all to answer is how much risk can you handle? One preferred measure is the concept of the first sleepless night.  If you have your first sleepless night when your overall portfolio is down 5% than that is your risk parameter.  It suggests that when your portfolio hits down 4% it’s time to reevaluate and recognize that more cash might be warranted.

Time horizon is also of paramount importance. As is often useful, we can examine Warren Buffett who has a time parameter of forever.  In January, 1998 Buffet purchases silver at an average price of $5.88. It would then proceed to go down over 30% over the next five years.  

Any other investor would have likely sold their position in the process, but Buffett held it and even added to it by purchasing physical silver and storing it. The price would not rebound fully until 2004 and he ultimately sold his position in 2006 for a 113% gain (13.6% annual return).

The issue of time horizon, and needing to produce results in the short run, can be a huge factor separating unsuccessful money managers from the likes of Warren Buffett. Institutional businesses, especially pension funds and endowments, are required to report quarterly results in great detail.

Rationale for decision making is reviewed, a manager’s style is questioned, and the results are scrutinized. A short term bias can often be observed when quarterly results are on the line, which can, in turn, lead to suboptimal decision making.

The individual who has made the decision to invest has only begun playing the game. The next step is limited by the assets available.  Very little useful guidance is available for portfolios of less than $100,000.

For these accounts, the optimal portfolio mix is 60-70% stocks via a low cost index fund, 20-30% U.S. Treasures, and 5-10% cash.  In reality, not until $250,000 or more will a knowledgeable broker/advisor even be mildly interested. Should you consider the help of a professional advisor consider the following points:

  • As mentioned before, know the source of the information.  Ascertain the individual’s academic and professional credentials.  You would do this at a doctor’s office, so why not here?
  • Be crystal clear on how the advisor gets paid.  Is it a flat fee or does the advisor get compensated based on specific funds?
  • Ask about investment objectives. Beating the market is often not suitable for many individuals due to the high level of risk that can be associated with that goal. Know what you’re chasing.
  • Discuss how much input you will have in the process. Does the advisor have complete control or can you call at any time and pick your allocation yourself?

Charlie Ellis, author of The Loser’s Game, has said: “investing should be a profession but it is not.” Ellis’ point is that most people do not treat investing as a lifelong learning experience. People should constantly be seeking new approaches, updating their skill sets, and continually questioning their current methods.  Sadly for investors, professionals have an attitude that suggests complacency and an unwillingness to seek out new ideas, develop useful information, and extend themselves.

In the rare case you do find a mutual fund with management that meets the above listed criterion, never buy a fund whose fees exceed 1%.  Also, be leery of funds that advertise too heavily, because after all, who is paying for those ads?  Lastly, determine if the fund’s record was achieved by the current manager.

Trading and Market Cycles

“Foul-cankering rust the hidden treasure frets, but gold that’s put to use more gold begets.”

–William Shakespeare

Much of the discussion up to this point has surrounded what not do, which sources of information are inaccurate, and the pitfalls of investing to avoid.  For the remainder, we will discuss what to actually do and what to pay attention to.

Any New Yorker will likely have heard “there’s another train right behind this one.” This is also true of the stock market, and patience is indeed, a virtue. The old cliché used to be “invest in haste, repent in leisure,” but no one has abided by that in a long time.

The first step is to simply know the state of the market.  Looking at a long-term chart, is the market in a bull or a bear market?  Secondly, assess the mood of the market. To gauge this it is important to take into account the anecdotal data mentioned above, but also corporate earnings, housing prices, S&P forecasts, GDP data, unemployment rates, and oil prices.

Market sentiment can be characterized in the following four buckets:

  1. Reluctance- this can’t be a bull market because I’m not in it.
  2. Consolidation- a chance to catch your breath.
  3. Acceptance- maybe I’ll get half invested.
  4. Exuberance- everyone jump in!

Of all the issues that analysts and investors should pay the closest attention, the greatest one is market cycles. It is important to note however, there are many cycles that are merely coincidental and should be consequently treated as such.  For example, some years back, a really big computer determined that of all the indicators the one that best fit the stock market’s result was butter production in Bangladesh.

Likewise, seasonal characteristics, such as sell in May and go away are trumpeted when they happen to coincide, but ultimately do not provide helpful insights.  The cycles that are important are the indicators or whether the market is truly in a bull or a bear market. As many have pointed out in the past, it is not terribly difficult to pick a gaining stock when the entire market is gaining.  

In general, the technology and the financial sectors are leading indicators of the overall market. They tend to lead bull markets and are about as close to a canary in the coal mine as we see.

Two other important cycles are small stock and value/growth. In an extensive study of the outperformance and underperformance of small stocks relative to large ones, no technical, fundamental, or rational basis was found to explain either phenomenon.  

This is yet another issue where anecdotal data reigns supreme. The empirical evidence doesn’t suggest that small stocks do well early in a market or economic cycle and no apparent trading strategy emerges simply from analyzing small stocks’ performance in different market cycles.

Growth stocks outperformed value stocks during bull markets and underperformed in bear markets. Surprisingly, value stocks do not actually fare that much better in declines than growth stocks. The contention that value does better in early stages of a bull or bear market has not proven to be accurate one way or the other.

The inconclusive nature of this cycle also applies to many other issues such as stock buybacks, insider activity, magazine covers, and the like.  They are all as likely to appear in up markets as down markets.

While market cycles aren’t easily anticipated, the effects of GDP and the economy do indeed have some repeatable and significant effects on the market cycle.  Strong GDP growth (greater than 3%) is manifested primarily by energy, technology, industrials, and materials.

Moderate GDP growth coincides with lackluster markets and limited sector movements.  Negative GDP growth leads to negative results across all sectors.

Picking Stocks

“The smart investor must know the difference between what is temporarily undervalued and what is permanently undervalued.”

–John Templeton

The concept of buying what you know is a good starting place but it should only be considered the seed of an idea.  To properly vet an idea before actually allocating capital to it, consider the following factors: revenue source (domestic or international), consistency of earnings, critical suppliers, major competitors, Wall Street opinions, and comments from management.  

Fundamentals are overrated.  One that is frequently mentioned is the competence of management.  This is a particularly nebulous and unquantifiable concept and one that should be given very little weight in the decision process.

Stocks with “sprained wrists” are of particular interest, as opposed to stocks that are broken. One should consider if an incident or development is likely short-term in nature, but is incorrectly being viewed by the market as a long-term problem. One such example of this can be viewed in the stock News Corp during mid-2011.  

News had broken out that the company was involved in tapping phones and engaged in bribery and other questionable practices at their London newspapers.  Moral judgments aside, the market was treating this as a significant long-term problem when it likely was a short term public relations issue. News Corp was a highly diversified company and the stock ended up rebounding dramatically in the following months.

Another example is the case of Lululemon in 2013. It was discovered that at least one batch of their popular yoga pants were somewhat see-through.  Despite the daunting negative consequences this could have, this was indeed a short-term supply chain issue and the stock ultimately reflected this and bounced back accordingly.

The phenomenon of capitulation regularly creates trading opportunities. When following any group of stocks, one will repeatedly find tickers that are in a seemingly unending downward spiral.  The absolutely bottom is regularly accompanied by really bad news. Hewlett-Packard in late 2012 is one such example.

HP just announced an $8 billion write-down of a prior acquisition of the company Autonomy.  Heavy selling and a it-can’t-get-any-worse mentality created a great buying opportunity. The stock has since more than doubled from its bottom.

It is important to know the “fingerprint” of a particular company’s stock.  In other words, have an idea of the patterns it typically exhibits and get a good feel of whether it’s in an uptrend or a downtrend.  This can be easier said than done, but it general, many stocks have consistent and repeatable patterns that they exhibit.  To undertake this analysis, you must be comfortable with the company.

Not necessarily the company’s product mix or other trivial characteristics, but as has often been said, “the most important fundamental is price.” Roland Grimm, of the Yale Endowment, once said, “You have to be careful regarding the railroad analyst who knows how many ties there are between New York and Washington and not when to sell Penn Central.”


“The gap between the rich and poor is widening fast.”

–Richard Rogers

Old market lore would suggest that a gap in a stock’s price must be closed…if it isn’t closed in three days it will be closed in three weeks, and if it isn’t closed in three weeks, it will be closed in three months.  But is this true? The answer is unclear.  The following tendencies are observed in the data:

  • Stocks that trade down 10% or more after hours are unlikely to move the next day.  They typically trade slightly higher in the pre-market and then migrate lower throughout the regular session.
  • Stocks that trade down 5-10% in after-hours are likely to decline even more the next day.
  • Most stocks that gain after-hours will continue higher the next day, regardless of the size of the gap.
  • Stocks that trade down 5-10% in the pre-market tend to have their losses concentrated before 9:30 am.

The old rule was that large gaps have to be closed. The new rule is more like 25% of the gaps will be closed. Stocks that trade down 15-20% tend to recover, especially three months after the event.  

Of the stocks analyzed, most of the major declines recovered somewhat. Of the major price gainers, stocks tended to trade a bit higher during the following week, and the majority continued higher over the subsequent month.

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Conclusion, You Must Remember the Following

“It is not the strongest of the species that survives, nor the most intelligent that survives.  It is the one that is most adaptable to change.

–Charles Darwin

The bearish case is always more compelling, rationale, and articulate. In fact, being bearish or cautious always sounds smarter than being bullish. But this is not the most profitable strategy in the long run. The market may not discount acts of nature, or malfeasance, or revolutions, but the market does do a very good job of collating, absorbing, and digesting information regarding earnings, interest rates, and the like.

People are always looking for a catalyst, or a reason why stocks are going up.  That is the wrong question to be asking. One should really be asking if we are in a bull market or a bear market. The instigator of the rally in March 2009 was a Citibank announcement that they had been profitable in the previous quarter. After that announcement, stocks didn’t need a catalyst.  They simply moved higher.

Most indicators are descriptive, not indicative. We have covered, in depth, how most indicators are simply telling what has already happened, and very few actually have anything to say about the future. Money flows is the one indicator that can lead market movements.

Discriminate between coincidental and causal. The butter production in Bangladesh was a good example of a mere coincidental phenomenon. Causality is much harder to observe in the market, and much rarer. Investing should be a profession; educate yourself. Gathering anecdotal data is a long, arduous task, but investing should not be easy.  Hard work, significant time commitment, and a dedication to the trade are necessary before any real success should be expected.

Trading Strategies

What does not work?

  • Technical analysis. It is not predictive, it is not consistent, and it is not analysis.
  • Taking the advice of market “gurus.” The Street can be more about marketing than the markets.
  • Fundamental analysis is overrated. Terms like “competence of management” are nebulous.

What does work?

  • Technical analysis can tell you if the market is an “overbought” condition or in an “oversold” condition. Buying the market in both states is profitable.
  • Money flows analyze every single trade in every single stock and are able to provide investors with information regarding future returns. 20% of the market is discounting some event at any given time, and money flows can signal how much information is actually incorporated into the stock price.
  • The ideal investment approach must incorporate: data, analysis, and strategy. Data must also include anecdotal data, which provides an accurate understanding of the sentiment of the market.
  • Market cycles produce some of the most tradable insights. The technology and the financial sectors are leading indicators of the overall market.
  • Stocks with “sprained wrists” create great buying opportunities. Look for short-lived bad news. Heavy selling and a it-can’t-get-any-worse mentality can also create great buying opportunities. would like to thank the Titans of Investing for allowing us to publish this content. Titans is a student organization founded by Britt Harris. Learn more about the organization and the man behind it by clicking either of these links.

Britt always taught us Titans that Wisdom is Cheap, and principal can find treasure troves of the good stuff in books. We hope only will also express their thanks to the Titans if the book review brought wisdom into their lives.

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