Financial Sense   Home  l  Broadcast  l  WrapUp  l  Storm Watch  l  About Us  l  Contact Us

EDUCATION OF AN INVESTOR
Pointing to a Better Way
by Robert B. Gordon, Sc. D.
December 10, 2002

INTRODUCTION

In my recent articles I have referred to myself as "do-it-yourself" investor and said that my education was in the school of "hard knocks" That was true up to 1995 when I turned 80. At that point in my life, I found a book on investing that completely changed, revolutionized is a better word, my thinking on the actions of the stock market. In this article we will describe our new approach in the hope that it will help readers advance their understanding of the markets to a higher level long before their 80th birthday.

First, we'll review the first 55 years of the learning process because our ability to recognize and accept the benefits of the new tool was certainly due in considerable part to my accumulated knowledge at that point in my life.

From the very large volume of mail from my readers, it has become very obvious that the American investing public of all ages needs help in acquiring the ability to manage their investments in good markets and bad. In the severe bear markets that I see in future years, the knowledge and techniques that worked in the late bull market will not suffice.

IN THE BEGINNING

Several months after receiving an advanced degree and starting work in a major corporate research laboratory, I walked into a broker's office and bought a few shares of 4 stocks. I have no idea what research was done to select the stocks, two of which are still in business. The next few years leave a blank in my memory with respect to investing. I do recall paying for the birth of two children with $25 patent disclosure awards from my employer. With an MD and a CPA now in the family, I consider it was a good investment.

In those days there were no company savings plans, very few mutual funds and no good sources of price data other than the major financial papers. My first exposure to mutual funds came from investing the assets of my widowed mother-in-law in very conservative bond funds, at least one of which survives to this day.

READING THE EXPERTS

With few funds to invest initially, I hit the book for a few years. I cannot recall the titles of the books where I was introduced to the Dutch Tulip Bulb Mania and the South Sea Bubble but Mackay's "Extraordinary Popular Delusions and the Madness of Crowds" is the best one to read now. A thoroughly enjoyable book was "Where are the Customer's Yachts" by Gerald Loeb, a famed Wall Street trader noted for his teachings of an "always liquid" account. This fascinating title is a sign that the brokers were riding high in the boom before 1929. Apparently, all the large yachts in the New York Yacht Club belonged to brokers!

I have read and recommend the great book on value investing "Security Analysis" by Graham and Dodd whose disciple, Warren Buffett, is the second wealthiest man in the world. I probably received more useful advice from Edwards and Magee's charting masterpiece "Technical Analysis of Stock Trends". From this book, my greatest benefit was learning the use of price moving averages to time buys and sells. In that period, with no computer and not even a hand calculator, the 10 day and 10 week averages were in great favor.

Some of these books are still available on the internet and all of them are probably available in a large library. An up-to-date Edwards and Magee edition could make a valuable resource for a serious investor.

THE GO-GO YEARS

It may be interesting to review the progress of the Dow from the 1932 low of 43 to its 1966 high of 1000. From that high level the Dow plummeted to 550 in 1974 and did not exceed 1000 for the 18 years to 1982 which was the start of the world's greatest stock market boom and mania.

Here are some interesting numbers. By 1937, the Dow had risen to just below 200 but then declined for nine years and did not go above 200 again until 1946. Here is a very noteworthy point, the Dow finally surpassed the 1929 peak in 1954, twenty five years later. It is interesting to speculate when the future Dow will exceed its 11,700 peak in early 2000. In my reading of the Elliott Wave Theory (details later) it could take a very long time.

The years of the 1960's saw the Dow rise from 500 to the temporary 1000 peak in 1966. The Go-Go years are best described as a mini-mania by today's standards but at the time were quite exciting. New mutual funds were promoted, rose to a quick peak and went broke at the first market downturn due to ownership of restricted securities that could not be sold to meet redemptions. I looked at the possibility of today's mutual funds facing a similar fate in a future market panic, but for a different reason in today's circumstances.

During this period of bullish emotions and rising markets I had reached a personal level of confidence in my investing skills such that I acquired a state security license and formed several limited investment partnerships with myself as General Partner and manager. One partnership traded mutual funds and the other traded stocks. I will not go into the details as I am not proud of my record. Let's just say that it proved to be a highly educational experience. It always better to be involved and learning rather than standing on the sidelines watching.

This time period is also known for its list of the Nifty Fifty stocks - One Decision High Flyer Stocks, that could be bought and never sold. The Go-Go years ended in a severe bear market that has had a permanent and beneficial influence on my subsequent investing years to this date. It provided some excellent experience to help prepare me for the current bear market, so we will discuss it at some length.

THE GREAT BEAR MARKET OF 1972-1974

At this time I was subscribing to a weekly investment service called the Indicator Digest. It published the weekly price of an Unweighted Average of 3000 NYSE stocks. Each week I carefully plotted the price on large 11 x 17" graph paper along with two moving price averages computed on my engineering slide rule as the only calculator available to me. After several subsequent family moves, this fascinating graph is the only remaining piece of information I have about this exciting period. I wish it could be reduced but has too much detail to permit that . In its full size, it reveals a dramatic picture of this long and deep bear market - longer and deeper than the public press has revealed.

The unweighted price average shows that the broad market started down in March 1972, months before the major averages peaked. It ended 64% lower at the end of December 1974. This contrasts with the 48 to 50% drop in the popular averages. Many well known mutual funds, some still here today, dropped by 70% or more. When this bear market ended near Christmas 1974, Wall Street was a desolate place. The bulls had long before stopped predicting a bottom so the bottom just slipped in quietly by itself. There was no rush of buyers until weeks and months later. In the trading system discussed below, a long trade entered two weeks after the bottom was sold 29 weeks late with a profit of 28.5%. For the well informed, the start of a new bull market is very profitable.

What follows will probably bore you but its important that you try and visualize why this serious bear period had a lasting impact on my life thereafter. If the current bear period is seized as an educational opportunity by our readers, it will have an enormous effect on their future investing. With that introduction, now visualize this 17" wide piece of graph paper, each vertical line representing a week in the years 1971 through 1975. Plotted weekly each weekend at the top is a plot of the Indicator Digest Average (IDA). Below that, on a much larger vertical price scale, is a graph of the two and eight week moving price averages used for trading. I was using the techniques learned years before from the Edwards and Magee book cited previously.

The IDA index proved to be a remarkable tool for timing the market but it needs to be emphasized that the index itself existed only on paper.  There was no security available that was intended to duplicate its performance.  In year 2002 it might be available to investors in the form of an Exchange Traded Fund.  Very unfortunately there is no very broad un-weighted average today to give a true picture of the market.  All we have are the capitalization-weighted averages produced by Wall Street to intentionally favor the large issues.

In the timing examples shown below, all of the trades were made on paper only. At the time they were used to follow the market’s direction and to be a trusted guide for trading other securities in the real market.  If the same moving average trading system were used today, an investor could readily hold long or short positions in the exchange traded funds for the NASDAQ and the other leading indices.

Every time the 2 week line broke above the 8 week line was a long buy signal. Every time the 2 week line broke below the 8 week line was a long sell signal. The graph page records the results of 6 long trades as follows:

Remember, this was hand calculation - no computer, no software, no calculator.

Every time the 2-week line broke below the 8-week line was a sell short signal. Every time the 2-week line broke above the 8-week line was a close short signal.

The overall result of the eleven long and short trades was a gain of 94%. What do these numbers reveal? Let me give my point of view. During the most severe bear market since 1929, this simple hand drawn chart is clear evidence of the benefits of doing your own work vs. following the advice of others. Of course at that time, there was no Money magazine, no Mutual Fund magazine and no CNBC to shape your thinking. If I had not been using Edwards and Magee's teachings, I would not have been able to develop and use a profitable moving average strategy for the bear market.

In some respects, investors are now suffering from the burden of too much technology. With daily prices from the Internet and complex software for charting and analyses, the danger of over kill is always present. Who would ever think in 2002 of using two simple arithmetic moving averages to tame a vicious bear market?

THE FINAL AND GREATEST LESSON

In 1995 at age 80, I discovered a vital missing link in my investment education. In reply to an ad, I purchased a copy of Robert Prechter's great book, At the Crest of the Tidal Wave. This monumental work is filled with charts and text which tell the story of a Grand Supercycle Wave starting in the London stock market in 1784 and which was, in 1995, in the fifth wave of five waves in the Supercycle Wave which started at the 1932 market bottom. The Elliott Wave Theory, developed by a brilliant retired accountant, Ralph Elliott, had shown that stock market impulse waves always have five waves , up or down, and that when completed, the market reverses its direction. Elliott's pioneering work showed this is true in every case, whether the wave involved is a tiny wave measured in minutes or a gigantic wave measured in decades. Eureka! In 1995, this meant that the great bull market from 1982 was in its final phase and that a bear market would follow.

Many decades of stock market history had shown a tendency for fifth waves to extend their length in very strong bull markets. Prechter had originally thought the expected great bear market might arrive in 1997, but later said that he could not predict the end of a mania. Earlier, he had predicted in writing in 1978 that a great new bull market was about to begin. Again, in this case, the forecast was correct, but 4 years early. My conclusion from this history is that the Elliott Wave Theory can confidently predict the market changes from bearish to bullish and from bullish to bearish. Is having this very important but imprecise timing information valuable or not?

The answer is a very strong yes because the imprecision in time shrinks with the size of the wave under consideration. Please know and remember that each impulse wave is made up of 5 smaller waves etc. etc. all the way down from centuries to seconds. So, in the real world, the current small wave may end a day longer or shorter which is not a serious problem. Earlier in his career, Prechter won a trading championship in the commodities market by using very short Elliott waves.

So, when each small fifth wave ends and a new first wave, up or down, commences, investors using the information can confidently execute their investment program. Action at each wave level leads to a predictable action at the next higher level. Each completed wave action, both up or down, leads to completing a wave structure at the level above etc., etc. until a massive decades long wave structure has been completed. Market action taken at that time, based on previous wave action, can be made with a high level of confidence.

I have mentioned the Elliott Wave Theory in my previous articles and recommended the reading of Prechter's great book (revised in 1997). I consider the EW theory my most valuable tool and would not consider any action in the current bear market without consulting the thrice weekly and monthly Elliott Wave reports.

SUMMING IT ALL UP

We certainly do not suggest that investors of any age try to repeat our 62-year story, but we do have a few suggestions:

1. If a large library is available, draw out some or all of the classic texts we mentioned. Some make hard reading while others read like a light novel.

2. Try at all cost to distance yourself from the constant stream of propaganda coming from Wall St. in the form of mutual fund and broker literature. It is very important that you learn as soon as possible that there are no easy shortcuts. Words, like asset allocation and rebalancing are not going to be helpful. And of course, when this bear market ends, words like "buy and hold" and "dollar cost averaging" will be in disuse for many decades.

3. Read as much as you can about the Elliott Wave Theory. There is a considerable amount of free material at the web site mentioned earlier. The Elliott Wave Forecast, available monthly for a surprisingly low price, can be worth a fortune to its reader over the next few years. Each month it gives a clear picture of the status of the most important of the Elliott Waves at that juncture. I highly recommend it based on my years of use.

IS THERE A BETTER WAY?

Of course, there is no need for anyone in this advanced age to repeat my tortuous path of progress from a very primitive technical environment. But the job of self education has to be done by each new investor. There is absolutely no help from our educational system that has a miserable record of accomplishment from kindergarten all the way through the college post graduate level.

We have a society where high school graduates can barely balance a check book and college finance courses, even at the graduate level, teach how company treasurers should issue new stock rather than how the students should manage their own investments. I speak from experience since I took a course from a distinguished professor in a major business school.

The dismal science of economics has yet to recognize and teach the Elliott Wave Theory, in my view, the greatest advancement in stock market knowledge in the past century. But recently I corresponded with a Chilean economics professor who authored an article on Gold-Eagle on applications of the wave theory. So, maybe things will be a little better fifty years from now.

My one hope for future progress in understanding stock market cycles is that finally, out of the depths of the current great bear markets, will emerge a better appreciation of the true greatness of Ralph Elliott who discovered his revolutionary theory from meticulous study of a huge number of stock charts. I, and a great many other investors, owe a debt of gratitude to his brilliant insights. I invite all my investor readers to become Elliotticians.

Go Top

© 2002 Robert B. Gordon, Sc. D.
Visit FSO's Cover Page for more editorials by Dr. Gordon

Robert B. Gordon, Sc. D.
Sun City West, Arizona
December 8, 2002
Email

Financial Sense   Home  l  Broadcast  l  WrapUp  l  Storm Watch  l  About Us  l  Contact Us