Whether you consider yourself a technical analyst or not, there are very few investing techniques that do not at least give a nod to the technical side of investing. Some investing styles use nothing but technical analysis, with their practitioners often claiming that they know nothing of stock fundamentals because all they need is in the charts. This segment of investing didn't sprout from nothing. In this article, we will look at the men that pioneered the field of technical analysis.
Tutorial: Technical Analysis
All Things Flow from Dow
Charles Dow occupies a huge place in the history of finance. He founded the Wall Street Journal – the benchmark by which all financial papers are measured – and, more importantly for our purpose, he created the Dow Jones Industrial Index. In doing so, Dow opened the door to technical analysis. Dow recorded the highs and lows of his average daily, weekly and monthly, correlating the patterns with the ebb and flow of the market. He would then write articles, always after the fact, pointing out how certain patterns explained and predicted previous market events.
However, Dow can't take all – or even a majority of - the credit for the theory bearing his name. Dow Theory would have only acted as a hindsight confirmation of loose principals if it weren't for William P. Hamilton. (To learn more, see Giants Of Finance: Charles Dow.)
First One into the Water: William P. Hamilton
Dow Theory was a collection of market trends linked heavily to oceanic metaphors. The fundamental, long-term trend of four or more years was the tide of the market – either rising (bullish) or falling (bearish). This was followed by shorter-term waves that lasted between a week and a month. And, lastly, there were the splashes and tiny ripples of choppy water insignificant day-to-day fluctuations.
Hamilton used these measures in addition to a few rules – such as the railroad average and the industrial average confirming each other's direction – to call bull and bear markets with laudable accuracy. Although he did call the 1929 Crash too early (1927, 1928), he made a final appeal on October 21, 1929, three days before the crash and mere weeks before his death at the age of 63.
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The Practitioner, Robert Rhea
Robert Rhea took Dow Theory and turned it into a practical indicator for going long or short in the market. He literally wrote the book on Dow Theory, "The Dow Theory." Rhea was successful at using the theory to call tops and bottoms – and able enough to profit from those calls. Very soon after mastering Dow Theory, Rhea didn't need to trade on his knowledge. He only had to write it down.
After calling the market bottom in 1932 and a top in 1937, the fortunes made by subscribers to Rhea's investment letter, Dow Theory Comments, brought in thousands more subscribers. As with Hamilton, however, Rhea's life as a market prognosticator was short - he died in 1939. (Learn more about the Dow Theory in our Dow Theory Tutorial.)
The Wizard, Edson Gould
Perhaps the most accurate forecaster with the longest track record, Edson Gould, was still making calls up to 1983 at the age of 81. Gould also made most of his money from writing newsletters rather than investing, selling subscriptions for $500 in 1930. He caught all of the major bull and bear market points, making several eerily accurate predictions, such as the Dow rising 400 points in a 20-year bull market, that the Dow would top 1040 in 1973 and so on.
Gould used charts, market psychology and indicators including the Senti-Meter – the DJIA divided by the dividends per share of the companies. Gould was so good at his trade that he continued to make accurate calls from beyond the grave, calling Dow 3,000 before his death. He was proven right even in this prediction that was considered on the very fringe in 1979, when he made it and the Dow had yet to break 1,000.
The Chartist, John Magee
John Magee wrote the bible of technical analysis, "Technical Analysis of Stock Trends" (1948). Magee was one of the first to trade solely on the stock price and its pattern on the historical charts. Magee charted everything: individual stocks, averages, trading volumes, basically anything that could be graphed. He then poured over these charts to identify broad patterns and specific shapes like weak triangles, flags, bodies, shoulders and so on.
Unfortunately for Magee, early on he was better at looking after his clients than his own portfolio, often selling out in his own portfolio based on gut feelings despite strong hold signals from his charts. From his 40s to his death at 86, however, Magee was one of the most disciplined technical analysts around, refusing to even read a current newspaper lest it interfere with the signals of his charts.
There is bound to be some controversy with a list like this. Where is the infamous Jesse Livermore? The trader whose gut calls on price ticks are arguably the first successful technical trades. What about R.N. Elliott? What about Gann?
Well, Livermore did little in the area of theorizing and died broke. Elliott tweaked technical analysis with his own hypothesis, but his theories are difficult to test and even harder to trade – involving something of mysticism piled on top of numbers. Similarly, Gann's lines, while seemingly useful in concept, are so sensitive to error that their practicality is questionable. Both of these men were purported to have made fortunes trading on their theories, but there is no solid record to back that up as there is for Livermore. Certainly no multi-million dollar estate was left behind by either.
The Bottom Line
Dow, Hamilton, Rhea, Gould and Magee are on the main track of technical analysis, each carrying the theory and practice a little further. There are of course, many branching side paths that, while interesting detours, didn't advance this main thrust. Every time an investor – fundamental or technical - talks about getting in low or picking entry and exit points, they are paying homage to these men and the techniques for which they laid the foundation. (To learn more about technical trading, check out Introduction To Types Of Trading: Technical Traders.)