Taming the Bear. Tate Christopher

ristopher Tate

      Taming the Bear: the art of trading a choppy market

      Wrightbooks Pty Ltd

      PO Box 270

      Elsternwick

      Victoria 3185

      Ph: [phone]

      Fax: [phone]

      Email: [email protected]

      Web site: www.wrightbooks.com.au

      © Christopher Tate 1999

      This book is copyright. Apart from any fair dealing for the purpose of private study, research, criticism or review as permitted under the Copyright Act, no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission. Inquiries to be made to Wrightbooks.

      National Library of Australia cataloguing-in-publication data:

      Tate, Christopher

      Taming the bear: the art of trading a choppy market

      1. Stock exchanges. 2. Stocks. 3. Investment analysis. 4. Portfolio management

      I. Title

      Includes index.

      ISBN: 1 875857 80 X

      332.642

      Cover design by Rob Cowpe

      The cover image was obtained from IMSI’s MasterClips/MasterPhotos^© Collection

      1895 Francisco Blvd. East, San Rafael, CA 94901-5506, USA

      The charts in this book were created using SuperCharts

      DISCLAIMER

      The material in this publication is of the nature of general comment only, and neither purports nor intends to be advice. Readers should not act on the basis of any matter in this publication without considering (and, if appropriate, taking) professional advice with due regard to their own particular circumstances. The author and publisher expressly disclaim all and any liability to any person, whether a purchaser of this publication or not, in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance, whether whole or partial, upon the whole or any part of the contents of this publication.

      PREFACE

      IF ASKED TO define a bear market, most investors would say that it is a period of continually declining prices in the entire market. Such an answer would be only partly correct. A bear market may encompass the entire market, but it can also affect a subsection of the market, such as gold stocks (as in 1997), or an individual stock, such as BHP.

      Furthermore, a bear market may not actually entail prices falling; prices may just drift sideways in a narrow band for a period of time.

      Our definition of a bear market, therefore, is any period when prices are not trending up. This period may be a week, a month or several years. To some extent we are not concerned with time, merely the opportunity to profit from a recognisable period of either price decline or consolidation.

      It is important for market participants to realise that the markets are not merely an elevator that goes one way, although this is a view held by many investment advisers, journalists and various “gurus”. Prices spend as much time going down as they do going up, and they spend the bulk of their time drifting in broad consolidation patterns. In fact, it has been estimated that the prices in all markets – be it shares, commodities or currencies – spend as much as 80 % of their time going sideways. Traditionally, such a situation would be extremely frustrating for average market participants, since they would, through a lack of knowledge, be unable to recognise that prices are going sideways. And if they did recognise this, they would lack the techniques to trade and profit from these sideways moves.

      “All men can see those tactics whereby I conquer, but what none can see is the strategy out of which victory is evolved.”

SUN TZU, THE ART OF WAR, 6TH CENTURY B.C.

      This book hopes to address both of these problems by demonstrating how to recognise bear markets as they emerge and how to trade both the sudden whips down and the broader consolidation patterns that they can represent. If you only have the intellectual or emotional capacity to trade bull markets, you are missing out on a whole range of opportunities offered by the market, and it will be a long time between drinks for you.

Christopher TateMelbourne, January, 1999

      PART I

      BEAR SPOTTING

      “In individuals, insanity is rare, but in groups, parties, nations and epochs it is the rule.”

NIETZSCHE

      1

      THE PSYCHOLOGY OF BEAR MARKETS

      BEFORE BEGINNING AN exploration of the various techniques and methodologies of bear market identification and trading, it is necessary to understand something about the psychology of the market. This chapter will set the tone for the rest of the book in that it will attempt to distil many of the motivations of traders during market swings.

      It has always been my contention that trading is primarily a psychological endeavour, and as such we need to understand our fellow traders. Once we understand what drives others to make decisions, our understanding of market dynamics is greatly enhanced. We will know why volume spikes at either the top or bottom of ranges, and how we can use this as a trading tool. We will know when to anticipate a change in market sentiment and how far this potential change is likely to go.

      THE BULL/BEAR MARKET CYCLE

      The bull/bear market cycle is the broadest definition we can possibly have regarding the cyclical nature of the market. Put simply, the market is initially dominated by the bulls. This is followed by an uneasy interregnum, followed by a swing in sentiment towards the bears. It is obvious that at any one point there will be a successful group, whose market view is confirmed by the current market trend, and an unsuccessful group, whose view is contrary to the trend.

      Each of these groups will have differing characteristics. The successful traders will be motivated largely by greed, and will tend to congregate in groups with other like-minded traders. This grouping together reinforces the prevailing opinion of the herd, thereby further driving prices in a given direction and further enhancing the success of the group. This is largely why trends, when started, continue: they exist on a limited-feedback loop that is reinforced for an indefinite period of time. If you want a practical example of this, take time to visit the market display area outside one of the exchanges. During bull markets, you will notice very large congregations of amateur traders – in effect a small, rather directionless herd. Take time to watch the reaction of the crowd. The mood is generally buoyant, everyone is talkative, and positive opinions about the market are reinforced.

      The unsuccessful group – whose opinions and strategies run counter to the prevailing market direction – has a different set of characteristics. Each member of the group is isolated and fearful. The members of the unsuccessful group are somewhat fragmented and disassociated from others. Again this can be seen in the market display area. Generally those by themselves during periods of peak market activity are those with a differing view to the majority. They may be long when it is time to be short, or vice versa. They might be attempting to counter-trend trade. This disassociation from the main group is to be expected. Within crowds, contrary opinions are not tolerated, and only become accepted when the opinion of the crowd changes. Consider the scene outside exchanges when market sentiment swings bearish very quickly. The majority of market participants never consider this to be a possibility. As such, their mood is pensive and withdrawn. There is no celebration, as everyone feels isolated within their own cocoon of fear.

      Within any market cycle, there will be those who are successful and those who are unsuccessful. There is no discrimination as to whether you are successful during a bull or a bear