Opinion: Legendary technical analyst’s ‘power index’ works for long-term stock investing

Article originally posted by Marketwatch on 23 Jun2 2017 at http://www.marketwatch.com/story/legendary-technical-analysts-power-index-works-for-long-term-stock-investing-2017-06-22

by Michael Kahn

Technical analysis can be lucrative for investors who look beyond daily market fluctuations.

Even today, technical analysis still gets a bad rap as being, at best, a self-fulfilling prophecy and, at worst, financial voodoo.

And while its practitioners are usually not good ambassadors for the discipline, that does not take away from its usefulness.

It is true that technical analysis — the study of data generated from the market through trading activity and sentiment — is most often associated with day traders and, unfortunately, get-rich-quick marketing. However, it is perfectly suited for use by traders who hold positions for a few days to a few weeks. And, more importantly, it is useful for investors interested in long-term commitments of several years or more.

For those who say they never met a successful technician, let me introduce Robert B. Peirce, a semi-retired portfolio manager with nearly a half century of success. When Bob sold his stake in his investment firm, the Pittsburgh-based Cookson, Peirce & Co., he had almost a half-billion dollars of assets under management and all of it was under the care of long-term technical analysis.

In fact, his methods for employing technical analysis to portfolio management earned him the 2010 award given by the Market Technicians Association. According to the awards committee, the biggest reason for the honor was his “long track record of running technical-analysis-driven portfolios.”

Peirce took his place next to such charting authorities as John Bollinger, Martin Zweig and Charles H. Dow.

 Trends have limited lives

Perhaps nobody seems to know much about professional investors who employ long-term technical analysis because they don’t talk about it much. Indeed, it makes for bad television because they don’t call tops and bottoms in the market. Peirce himself once said that it is virtually impossible to sell long-term market timing. It’s just not as sexy as trying to prophesize the ebbs and flows that dominate the short-term.

Instead, long-term practitioners of technical analysis look for major trends to exploit. And since these trends are long term, by definition they do not change with the news cycle.

The most recent example was the June 9 technology sector selloff, which got pundits scrambling to declare the end of the reign of these leaders and trouble for the market as a whole. To a long-term investor, one day or even one week of volatility is but a blip on a chart.

His approach recognizes that leadership changes in the market over time. There will be periods when growth beats value, or when one market capitalization leads and then lags the others, and the goal is recognize this in order to make money in any environment. This allows him to buy small-cap stocks when they look strong, and by following a disciplined sell methodology, he may end up in large-cap value stocks at a different point in the market cycle.

The whole idea is that trends have limited lives. If you wait too long to get in you should just look for something that is timelier. If you wait too long to get out, you give up too much of your gain. Sometimes sectors stay strong for years, but they are usually strong for 12-18 months.

Peirce’s ‘power index’

Bob uses a combination of indicators based on market cycles, sentiment, breadth, market strength, and monetary indicators. While he tracks more than 70 of them, he trims them down to the 15 with the best recent records, revising the set every January. In this way, his model adapts to an ever-changing market over time.

If the majority of indicators are bullish, then he adopts a more bullish stance in his portfolio and even applies leverage when appropriate. In order to decide how aggressive to be, he created what he calls the “power index,” which is an overbought/oversold indicator based on market breadth.

The theory is that a strong market has strong breadth, which means a larger percentage of stocks are rising than falling. The opposite is true for a weak market.

But as with all overbought/oversold indicators, when it swings too far in one direction, it also tells him to take action. If he thinks it is a bull market, a very low reading tells him it is time to put new cash to work. If he thinks it’s a bear market, a very high reading tells him to use the strength to sell positions, as needed.

In other words, it fine-tunes what he was already doing: participating in a bull market or sitting out a bear market.

In a weak market, breadth should be weak. However, it can become so weak that it indicates huge levels of fear and dislike for stocks. That can signal good buying opportunities.

Over his career, Peirce has shared his thinking freely with colleagues because he was not trying to promote a “black box” style as so many others were trying to do. He also compiled a solid track record of long-term calls. Again, there is very little media coverage when he makes them because we will not know if he is right or wrong for years.

Dow call in 2010

But in May 2010, when the Dow Jones Industrial Average was hovering near 10,500, he said: “I believe we are in an ongoing bull market that could have a long way to go.” He also recognized the potential for short-term weakness (May and June were down months) but the overriding goal was not to be shaken out of his long positions in a bull market.

Bob lamented that the biggest disappointment of his career has been that the individual investor has not embraced long-term market timing. Again, that is because he operates in the long-term where patience is a virtue and media soundbites are rare.

And what does he think about the stock market now? He is still bullish heading into the summer months and encouraged by what he sees. However, since he is not in the prediction business, he’ll let the indicators guide him each month.

Michael Kahn, a chartered market technician (CMT), is a columnist for MarketWatch as well as Barrons.com, where he writes the “Getting Technical” column. He is the author of three books on charting and comments on technical analysis on his Twitter feed.

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