CHAPTER SIX Market Technique

ON Saturday morning, February 27, 1909, the market opened slightly higher than the previous night's close. Reading was the most active stock. After touching 123 1/2 it slid off to 122 1/2, at which point it invited short sales. This indication was emphasized at 122, at 121 1/2 and again at 121. The downward trend was strongly marked until it struck 119 7/8, then it followed a quick rally of 1 1/8 points.

This was a vicious three-point jab into a market that was only just recovering from a decline in early February. What was its effect on the other principal stocks? Union Pacific declined only 3/4, Southern Pacific 5/8 and Steel 5/8. This proved that they were technically strong; that is, they were in hands which could view with equanimity a three-point break in a leading issue. Had this drive occurred when Reading was around 145 and Union 185 the effect upon the others would probably have been very different.

In order to determine the extent of an ore body, miners use a diamond drill. This produces a core, the character of which shows what is beneath the surface. If it had been possible to have drilled into the market at the top of the foregoing rise, we should have found that the bulk of the floating supply in Steel, Reading and some others was held by a class of traders who buy heavily in booms and on bulges. These people operate with comparatively small margins, nerve and experience. They are exceedingly vulnerable, so the stocks in which they operate suffer the greatest declines when the market receives a jar.

The figures are interesting:

1907-09 Advance Feb 09 Decline % Break to Advance
U.P. 84 1/4 12 3/8 14.7
Reading 73 1/4 26 3/8 33.6
Steel 36 1/4 16 1/2 44.6

The above shows that the public was heavily extended in Steel somewhat less loaded with Reading, and was carrying very little Union Pacific. In other words, Union showed technical strength by its resistance to pressure, whereas Reading and Steel offered little or no opposition to the decline.

Both the market as a whole and individual stocks are to be judged as much by what they do as what they do not do at critical points. If the big fellows who accumulated Union below 120 had distributed it above 180, the stock would have broken something like thirty points, due to its having passed from strong to weak hands. As it did not have any such decline, but only a very small reaction compared to its advance, the Tape Reader infers that Union is destined for much higher prices; that it offers comparative immunity from declines and a possible large advance in the near future. Even were Union Pacific scheduled for a thirty-point rise in the following two weeks, something might happen to postpone the campaign for a considerable time. But the Tape Reader must work with these broader considerations in full view. He has just so much time and capital, and this must be employed where it will yield the greatest results. If by watching for the most favourable opportunities he can operate with the trend in a stock which will some day or week show him ten points profit more than any other issue he could have chosen, be is increasing his chances to that extent.

A long advance or decline usually culminates in a wide, quick movement in the leaders. Take the break of February 23, 1909: Reading declined from 128 3/4 to 118 and Steel from 46 to 41 1/4 in one day. Southern Pacific, after creeping up from 97 to 112, reached a climax in a seven-point jump during one session.

Instances are so numerous that they are hardly worth citing. The same thing happens in the market as a whole - an exceptionally violent movement, after a protracted sag or rise, usually indicates its termination. A stock generally shows the Tape Reader what it proposes to do by its action under pressure or stimulation. For example: On Friday, February 19, 1909, the United States Steel Corporation announced an open market in steel products. The news was out. Everybody in the country knew it by the following morning. The Tape Reader, in weighing the situation before the next day's opening, would reason As the news is public property, the normal thing for Steel and the market to do is to rally. Steel closed last night at 48 3/8. The market hinges upon this one stock. Let's see how it acts." The opening price of U. S. Steel was three-quarters of a point down from the previous closing - a perfectly natural occurrence in view of the announcement. The real test of strength or weakness will follow. For the first ten minutes Steel shows on the tape:

200 @ 47 7/8
4500 @ 47 3/4
1200 @ 47 7/8
1500 @ 47 3/4

without otherwise varying. Eighteen times the price swings back and forth between the same fractions.

Meanwhile, Union Pacific, which opened at 177 1/2, shows a tendency to rally and pull the rest of the market up behind it. Can Union lift Steel? That is the question. Here are two opposing forces, and the Tape Reader watches like a hawk, for he is "going with the market" - in the direction of the trend. Union is up 7/8 from the opening and Southern Pacific is reinforcing it. But Steel does not respond. Not once does it get out of that 3/4 - 7/8 rut - not even single hundred share lot can be sold at 48. This proves that it is freely offered at 47 7/8 and that it possesses no rallying power, in spite of the leadership displayed by the Harrimans. Union seems to make a final effort to induce a following:

2000 @ 178 1/2

to which Steel replies by breaking through with a thud:

800 @ 47 5/8

This is the Tape Reader's cue to go short. In an instant he has put out a line of Steel for which he gets 47 1/2 or 47 3/8 as there are large volumes traded in at those figures. Union Pacific seems disheartened. The Steel millstone is hanging round its neck. It slides off to 178 ž, ź, 1/8 and finally to 177 7/8. The pressure on Steel increases at the low level. Successive sales are made as follows.

6800 @ 47 ˝
2600 @ 47 3/8
500 @ 47 1/4
8800 @ 47 1/8

From this time on there is a steady flow of long stock all through the list. Reading and Pennsylvania are the weakest railroads. Colorado Fuel breaks seven points in a running decline and the other steel stocks follow suit. U.S. Steel is dumped in bunches at the bid prices, and even the dignified preferred is sympathetically affected.

At the end of the two hour session, the market closes at the bottom, with Steel at 46, leaving thousands of accounts weakened by the decline and a holiday ahead for holders to worry over. It looks to the Tape Reader as though the stock would go lower on the following Tuesday. At any rate, no covering indication has appeared, and unless it is his invariable rule to close every trade each day, he puts a stop at 47 on his short Steel and goes his way. (His original stop was 48 1/8). Steel opens on the following session at 44 ž @ 1/2, and during the day makes a low record of 41ź.

A number of lessons may be drawn from this episode. Successful tape reading is a study of force; it requires ability to judge which side has the greatest pulling power and one must have the courage to go with that side. There are critical points which occur in each swing, just as in the life of a business or of an individual. At these junctures it seems as though a feather's weight on either side would determine the immediate critical trend. Any one who can spot these points has much to win and little to lose, for he can always play with a stop placed close behind the turning point or "point of resistance". If Union had continued in its upward course, gaining in power, volume and influence as it progressed, the dire effects of the Steel situation might have been overcome. It was simply a question of power, and Steel pulled Union down. This study of responses to stimulation or outside influences on stocks is one of the most valuable in the Tape Reader's education. It is an almost unerring guide to the technical position of the market. Of course, all responses are not so clearly defined.

It is a matter of indifference to the Tape Reader as to who or what produces these tests, or critical periods. They constantly appear and disappear; he must make his diagnosis and act accordingly. If a stock is being manipulated higher, the movement will seldom be continued unless other stocks follow and support the advance. Barring certain specific developments affecting a stock, the other issues should be watched to see whether large operators are unloading on the strong spots. Should a stock fail to break on bad news, it means that insiders have anticipated the decline and stand ready to buy.

A member of a trading syndicate once said to me: "We are going to dissolve tomorrow." I asked, "Won't there be considerable selling by people who don't want to carry their share of the securities?" "Oh!" he replied, "we know how every one stands. Probably 10,000 shares will come on the market from a few members who are obliged to sell, and as a few of us have sold that much short in anticipation, we'll be there to buy it when the time comes." This reminds us that it is well to consider the insider's probable attitude on a stock. The tape usually indicates what this is. One of the muckraking magazines once showed that Rock Island preferred had been driven down to 28 one August to the accompaniment of receivership rumours. The writer of the article was unable to prove that these rumours originated with the insiders, for he admitted that the transactions at the time were not fully understood. Perhaps they were inscrutable to a person inexperienced in tape reading, but we well remember that the indications were all in favour of buying the stock on the break. The transactions were very large - out of all proportion to the capital stock outstanding and the floating supply.

What did this mean to the Tape Reader? Thousands of shares of stock were traded in per day, after a ten-point decline and a small rally. If the volume of sales represented long stock, someone was there to buy it. If there was manipulation it certainly was not for the purpose of distributing the stock at such a low level.

So, by casting out the unlikely factors, a Tape Reader could have arrived at the correct conclusion. The market is being put to the test continually by one element of which little has been said, i.e., the floor traders. These shrewd fellows are always on the alert to ferret out a weak spot in the market, for they love the short side. Lack of support, if detected, in an issue generally leads to a raid which, if the technical situation is weak, spreads to other parts of the floor and produces a reaction or a slump all around. Or, if they find a vulnerable short interest, they are quick to bid up a stock and drive the shorts to cover.

With these and other operations going on all the time, the Tape Reader who is at all expert is seldom at a loss to know on which side his best chances lie. Other people are doing for him what he would do himself if he were all-powerful. While it is the smaller swings that interest him most, the day trader must not fail to keep his bearings in relation to the broader movements of the market. When a panic prevails he recognizes it in the birth of a bull market and operates with the certainty that prices will gradually rise until a boom marks the other extreme of the swing. In a bull market he considers reactions of from two to five points normal and reasonable. He looks for occasional drops of 10 to 15 points in the leaders, with a 25-point break at least once a year. When any of these occur, he knows what to look for next. In a bull market he expects a drop of 10 points to be followed by a recovery of about half the decline, and if the rise is to continue, all of the drop and more will be recovered. If a stock or the market refuses to rally naturally, he knows that the trouble has not been overcome, and therefore looks for a further decline.

Take American Smelters, which made a top of 99 5/8 a few years ago, then slumped off under rumours of competition until it reached 78. Covering indications appeared around 79 1/2. Had the operator also gone long here, he could confidently have expected Smelters to rally to about 89. The decline having been 21 5/8 points, there was a rally of 10 3/4 points due. As a matter of record the stock did recover to 89 3/8.

Of course, these things are mere guide posts, as the Tape Reader's actual trading is done only on the most positive and promising indications; but they are valuable in teaching him what to avoid. For instance, he would be wary about making an initial short sale of Smelters after a 15 point break, even if his indications were clear. There might be several points more on the short side, but he would realize that every point further decline would bring him closer to the turning point, and after such a violent break the safest money was to wait for an opportunity on the long side. Another instance: Reading sold on January 4, 1909, at 144 3/8. By the end of the month it touched 1311/2, and on February 23rd broke ten points to 118. This was a decline of 24 3/8 points (allowing for the 2 per cent dividend paid). As previously stated, the stock looked like an attractive short sale, not only on the first breakdown, but on the final drive. The conservative trader would have waited for a buying indication, as there would have been less risk on the long side.

It is seldom that the market runs more than three or four consecutive days in one direction without a reaction, so the Tape Reader must realize that his chances decrease as the swing is prolonged. The daily movements offer his best opportunities; but he must keep in stocks which swing wide enough to enable him to secure a profit. As Napoleon said: "The adroit man profits by everything, neglects nothing which may increase his chances".

I once knew a speculator who bought and sold by the clock. He had no idea of the hourly swing, but would buy at 12 o'clock, because it was 12 o'clock, and would sell at 2 o'clock, for the same reason. The methods employed by the average outside speculator are not so very much of an improvement on this, and that is why so many lose their money. The expert Tape Reader is diametrically opposed to such people and their methods. He applies science and skill in angling for profits. He studies, figures, analyzes and deduces. He knows exactly where he stands, what he is doing and why.