“It is the mark of an instructed mind to rest satisfied with the degree of precision to which the nature of the subject admits and not to seek exactness when only an approximation of the truth is possible.” — Aristotle
A Double Bottom, Not a Double Bottom
It was the closest thing to an “ugly” moment that I believe I’ve ever had in 10 years of teaching workshops.
Five or six years ago, I was presenting a lesson on double tops and bottoms in a swing trading workshop for the Van Tharp Institute.
As we looked at the double bottom formation in October 2002 on the following chart (yes, this exact same chart), one guy in the front row declared loudly that this was not a double bottom. 485-dr-chart1.jpg 42,91К 0 Количество загрузок:
You may notice if you look very carefully, as this particular fellow did, that the culmination of the second bottom on 10/10/2002 actually traveled a bit lower than the first low back in July.
I explained my belief that technical analysis is about finding reactions at zones or areas on a chart rather than at precise points. For all intents and practical purposes, the October low met the double bottom criteria.
But he would not have it and did not let it go. A double bottom must not penetrate the original bottom, this did not count, yadda, yadda, yadda.
This went on for a little while. So to drive the point home finally, I pulled out my “ace in the hole” about this particular market double bottom. I related a conversation I had with quite a few hedge fund managers at the Long Island home of my best friend and business partner, Christopher Castroviejo. This was late in 2002, and several months after the market double bottom in the chart above. Quite a few of the managers told us their funds had gotten absolutely hammered for the first three quarters of 2002. Thanks to this one great double bottom signal in October, however, they nearly all got well for the year (they shored up their profits).
Well, even those big guns didn’t help. The broad based consensus from a group of seasoned professionals that the October low was a double bottom was simply unconvincing to this attendee. His demand for precision prevented him from seeing what many others saw plainly. He was indignant and held fast that the October low was assuredly not a double bottom. In the end, we agreed amicably to disagree. I bet he’s still searching for absolute precision in the markets…
Back to Zones
Aristotle’s quote at the beginning of the article is highly instructive for traders. To paraphrase, instructed minds don’t look for more precision than the environment can provide. It’s almost like the great Greek philosopher was thinking about the financial markets when he wrote that.
Aristotle’s concept reminds me of my favorite description of financial markets:
“They are not a problem to be solved, but psychology to be understood.”
Let’s think about how this understanding plays out in the chart pattern we’ve been discussing—a double top or bottom.
Could you believe that close to the second top or bottom, market players might get anxious and try to reverse the market’s direction before the price actually hits the exact tick of the previous top/bottom? Or could you imagine market players getting overly greedy or fearful causing the price or index to overshoot the original level by a few ticks? Of course.
Membranes Give a Little
To help familiarize us with the idea of zones, we can think in terms of a useful metaphor. Think of a zone as a membrane. Imagine a friend stretching out a non-inflated balloon for you. What happens if you try to a push a ball point pen through the latex? Does it poke through immediately? No. The latex will have some “give” before the point pierces the membrane.
The same can be said for support and resistance levels in the market. They can «give» some and flex a bit before they are broken or violated.
Remember to think in terms of zones rather than very precise prices or points in the markets. Doing so will reduce the stress of trading and investing. Thinking in terms of zones will also help you understand better how normal market behavior allows for a bit of “psychological” leeway rather than providing scientific precision.