The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

03 May 2009

Measure trends objectively vs subjectively: Which is better?

Price equals risk, I state often; I am not alone in that sentiment. Alas, with so many methods to measure price, they amount as too many. Two technical measures of price (action) include:
1) Price measured from a breakout, whether short, intermediate, or long term;
2) Price measured from a low, whether primary, secondary, or tertiary.

The two simple items above count as six (6) distinct measures -- and do not even begin to scratch the surface. To reduce to the irreducible, the two crucial perceptions are subjective and objective. And while the subject of this post is not Green Mountain Coffee Roasters/GMCR, it does qualify as an excellent example.

These two commenters (1 and 2) are on the right track, but use subjective analysis. Where, for example, do they include objective measures that offer proof that a change in price dynamics is about to occur? They state only that change will occur, not how and how to recognize it. Commenter #1 states,

"I’m fairly confident that this stock will have a sharp pullback in the coming weeks and one that could be very profitable if timed quickly."
Unfortunately, he offers no quantifiable or objectively measurable reasons why such a situation will arise, nor how to view such change if and when it occurs. He also neglects to add whether the decline will be for months, weeks, days, or minutes, or from primary up trend to primary down trend, even whether the decline warrants careful attention as a moment to purchase rather than to sell or sell short.

Those same thoughts hold true for Commenter #2, who states,

"the stock is now trading at a huge premium to market"
Though a more objective measure, I nonetheless ask, "So, what of it? Many stocks trade at a premium (and at a discount) to the market; what makes GMCR different and deserving of a sale?" In its monolithic way, the market averages performance, and yet individual stocks can, and are, outliers to that pattern. These outliers create your opportunities to profit.

Subjective analysis can, does, and should play a role in your portfolio investing. For example, as an investor, you could decide in advance the price or value level that offers the most comfort for your sale, irrespective of subsequent price action. No more kicking yourself because a stock continued its rise -- after you sold. And vice-versa. Objective analysis, on the other hand, offers crucial insights, because, over the long run, the markets are a weighing machine; i.e., while you might be smarter than anyone you are not smarter than everyone.

Consider, once again, Green Mountain Coffee Roasters/GMCR...

[Click on charts to enlarge]

You and I, able to perceive only three dimensions, typically view charts like the one above via the x and y axes of price and time. (Other axes deserve our attention, but are not the topic of this post.) So we draw trend lines like those I delineate, which circumscribe price moves, but ignore the element of time. Oh sure, we know now that the price meandered sideways for ~26 months, but what does that knowledge tell us, if anything, about when the stock will break out (up or down)?

Viewed differently, but still relying on the Cartesian coordinates, we can see this...

Carried over from the prior chart is the trend line at $45 that delineates the breakout from the high-level consolidation; I added:
1) The small and internal double bottom (#1);
2) The breakout (price and volume highlighted in yellow);
3) The internal rising bottoms trend line that occurred since the second low of the double bottom, which forms an...
4) Ascending Triangle, which breakout typically is quite bullish -- and occurred at $45.

We know already what happened. Remember that the up trend I identify began in the depths of the recent, especially ferocious, bear market, which caused most traders and analysts (but one) to see only lower prices and deeper declines immediately ahead. And yet Green Mountain/GMCR has forged higher amid increasing incredulity.

So, yes,
Green Mountain/GMCR enjoys a powerful up trend, now ~5 1/2 months old. That up trend, though, gives rise to a sequence of questions:
1) For how long do such trends endure?
2) How do I measure trends predicated on time, not price?
3) How can I use time to measure change?
4) How can I combine the x and y axes (price and time, or the z axis) to identify risk (high price and high value relative to a constant) and opportunity (low price and low value relative to a constant)?

The answers to these questions and others must await a future post. This post merely introduces the concept, sets your curiosity free to roam, and even encourages you to share your perceptions and thoughts so that we all could discuss the notion together.

Full Disclosure: Long Green Mountain Coffee Roasters/GMCR.
-- David M Gordon / The Deipnosophist

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