A reader added some interesting comments to my post about the NYSE Bullish Percentage Index ($BPNYA) and I wanted to expand on my response.
My parents divorced when I was an infant and I seldom saw my father, since I lived with my mother far away. But when I was ten, my father bought me a plane ticket and I visited him for a week. I noticed that he was living quite well, but he seemed to have no occupation other than planning a trip to Europe, so I asked if he had a job. He said his job was to be an investor. I asked what kind of an investor he was. He said he was an alligator investor. My father explained there are two kinds of investors: alligator investors and crocodile investors. Alligator investors lie at the bottom of the stream waiting for something good to eat to swim by, and crocodile investors charge out of the stream to hunt for their prey. Crocodiles waste energy and expose themselves to risk, but in the end they don’t get any more to eat than alligators. My father said that he invested by waiting for good stocks to go down a lot, then he bought and held them for the long haul. I never saw him look at a stock chart, but when he passed away he left a substantial estate.
Twenty years later I became interested in the financial markets myself. I started investing in a mutual fund regularly, and I also began to trade stocks, options, and commodity futures. I studied technical analysis in depth and tried many mechanical trading systems which I hoped would give me an edge. I bought and sold short constantly for several years. Here is how I happened to give up leveraged trading: I saw that I was up about 20% for the year, but filing my tax return was an absolute nightmare because of all the short-term trading. In the meantime, my mutual fund was also up 20%, but effortlessly! Then I remembered what my father had said about alligator investors and crocodile investors, and vowed to become an alligator investor myself.
We have had a great bull market in this country for many generations. That bull market has been punctuated by corrections of varying magnitude, but using sell signals to bail out of stocks completely is a fool’s pursuit. What works best is buying good securities when they are cheap and holding on to them. If you don’t have the time, the inclination, or the patience to study the market and wait for what you want to go on sale, dollar cost averaging works almost as well; all you really need to do is carefullly select one or two good, low-cost funds which suit your investment goals and invest away, regularly – you should succeed in the end.
This is not to say that technical analysis doesn’t work. You just need to find technical analysis tools that suit your trading style. For an alligator investor, $BPNYA is an excellent tool. He will not be looking for in-and-out trading signals, but when $BPNYA does give a reading below 30%, like it did in 2002, he knows it is time to buy stocks aggressively, even high-beta tech stocks. He will have to overcome his fear. The market will look terrible and the future will look dismal. Years later, when $BPNYA is giving a reading over 70%, he will not be looking to sell his stocks, even though he has big profits. He will know that it is time to weed out his portfolio, selling laggards and the clutter that accumulates after mergers and spinoffs. When $BPNYA is over 70% it will seem foolish to sell anything, because the Dow will be making new highs amidst encouraging predictions about the economy and interest rates.
Of course an alligator investor will use other technical tools as well. For example, he will study the list of new 52 week lows every day. And if he has the time and inclination, he will chart unloved stocks which pay good dividends, using technical studies which may be helpful in determining trend changes, such as moving averages, RSI, and on-balance volume. But these refinements are unnecessary, strictly for entertainment and intellectual stimulation! The main thing is to buy low, accumulate, diversify, and hold.