Analytical Framework

Being a teacher, Hank is able to define complex issues in simple terms. Applying this skill to trading, he found that traders like to use analogies to explain their world and to help them capture a deeper understanding of what it takes to be a complete, high performer. A favorite field from which to draw analogies is competitive athletics. One attractive analogy for the three part skills of the complete trader is the “triple threat” notion in football.

In the early 1950s, TIME magazine ran a cover story on the then Princeton University All-American Dick Kazmier. The cover story was titled “A Triple Threat from a Single Wing.” Princeton’s football team operated out of a “single wing” formation. Kazmier personified the complete football player of his era: he was outstanding at the run, the pass and the kick. These three complementary talents, combined into one individual, made Kazmier an awesome competitor and an All-American performer. Applying this analogy to trading, Hank found that the 3-in-1 Trader must seek to develop a “triple threat” skill set. It is not running, passing and kicking, but rather:

1. Systems building
2. Pattern recognition
3. Mental state management

These three decision frameworks, illustrated in Figure 1, interact with each other and build on each other in a natural order of progression. A behavioral finance framework for system building provides the structure for integrating and interpreting indicators organized along the key dimensions of price, time, volume, and sentiment. A pattern recognition scheme for discretionary trading, such as the Wyckoff Method of chart reading and of technical analysis furnishes the trader with an almost ideal set of laws and principles that the trader can use as general guidelines to interpret chart patterns and to take action. A model of trader psychology for mental state control is needed for success in system or discretionary trading. Hank’s collaborative research with Dr. Van K. Tharp led to “The Ten Tasks of Top Trading,” a series of discrete contexts for selecting appropriate mental states and providing a logical and comprehensive sequence of tasks for the successful trader to follow. Pertinent papers can be found at http://www.hankpruden.com/tentasks.pdf

Hank relies primarily on the Wyckoff Method of technical analysis. He likens this approach to Woody Hayes’ football philosophy at Ohio State - “three yards and a cloud of dust.” Although neither approach is fancy, both are effective and both produce winners.

Richard Wyckoff was a trader in the early-to-mid 1900s. He tried to understand the logic behind market action. Like Hank Pruden, Wyckoff was able to explain complex issue in understandable terms, such as “Are you riding a dead horse? Get off and get a live one.” (from Fourteen Methods of Operating in the Stocks Market, 1909/24, as quoted by John Bollinger, CFA, CMT in Capital Growth Topics, May 18, 2001)

By studying the actions of Jesse Livermore, James Keen, J.P. Morgan, and other stock operators of his day, Wyckoff developed a trading system which sought to explain the boom and bust cycle in stocks. The Wyckoff Method uses price charts and volume studies to analyze and forecast the stock market. It also takes into account investor psychology and provides insight into why professional traders buy and sell stocks. Wyckoff emphasized the placement of stops and the importance of controlling the risk of any particular trade. Successful implementation of his model allowed Wyckoff to own a mansion in the Hamptons.

A successful trader from Lebanon introduced Hank to this approach. After much study and practice, he realized this approach made a lot of sense to him, and it has been at the core of his analysis ever since. Hank also finds that teaching reinforces the concepts of the Wyckoff Method, and he has also found that most students who study this method are able to profitably employ it, given sufficient study and practice.

Hank has also sought to expand upon Wyckoff’s work. To this end, he has added some definition to several concepts. As an example, he has refined a checklist to identify market turning points during periods of consolidation. He has also added to the body of knowledge by creating a checklist to assess whether or not that consolidation will lead to a resumption of the prior trend. To obtain an overview of this investment tactic, readers may refer to Hank’s articles, “Wyckoff Laws: A Market Test” in the 2004 issue of the IFTA Journal and “Wyckoff Tests: Nine Classic Tests and Nine New Tests” which appeared in the Spring-Summer 2000 issue of the MTA Journal. This article is available at http://www.hankpruden.com/nineclassic.pdf

Hank also has been working with Cusp Theory to study market behavior. In the Winter-Spring 2004 issue of The Journal of Technical Analysis, Hank co-authors an article entitled, “Interpreting Data from an Experiment on Irrational Exuberance: Applying a Cusp Catastrophe Model and Technical Analysis Rules” which explains this effort. His co-authors Paranque and Baets are at the Euromed-Marseille Ecole de Management.”

Cusp Theory is useful to explain the tools of technical analysis, and may provide the mathematical tools to explain why the Wyckoff Method works. In the experiment described in the Journal article, Hank and his co-researchers observed that a collective irrationality drove members of the group. Others chose not to participate in a clearly overvalued market, and thus had no chance of winning. However, disinterested, outside observers would have been able to spot the awaiting calamity just by watching the price patterns emerge. While technical analysis captures the patterns of human behavior, Cusp Theory explains that behavior. Hank feels that this may be among the greatest contributions of Cusp Theory – reinforcing the fact that despite a human tendency to seek complex answers, simple information such as trendlines may be highly predictive of future price movements.

Current Views

At this time, Hank believes that the major trend indicators, such as classic Dow Theory and 200- day moving averages of the major indices, are the keys to understanding the current market. His Wyckoff analysis gave major signs of accumulation followed by the start of a cyclic bull market in 2002-2003. Adding cyclic analysis to the equation, he finds that we are in a dominant bull trend with expectable corrections until a top is reached, most likely in 2005. In “Wyckoff Laws: A Market Test,” published in the 2004 issue of the IFTA Journal, Hank and Professor Belletante of Euromed-Marseille projected a target of 14,400 on the DJIA, expected to occur in 2005. Thereafter, as he explained in a May-June 2004 presentation in Mexico City, he anticipates a trading-range market reminiscent of the 1970s.

Closing Advice

Hank firmly believes that in knowledge, there is power. Those seeking to master technical analysis need to attain basic knowledge and practical skills of the field before risking their assets. Investors at all levels often underestimate the level of skill required in this profession. Hank encourages newcomers to read the books written by John Murphy and Martin Pring as a starting point. He also considers Edwin LeFevre’s classic “Reminiscences of a Stock Operator” to be required reading. Experiential learning is also valuable in this field; well guided experience can save a great deal of time and losses for new traders.

For the past seven years, Hank has been in demand worldwide, addressing professional societies and portfolio managers in Japan, Australia, Sweden, Singapore, Iceland, Italy, the Netherlands, Denmark, Germany and Canada. He also counsels investors in his offices in San Francisco and in their home countries. For more information about Hank’s work, please see www.hankpruden.com

Hank welcomes the opportunity to discuss introducing technical analysis into European and Middle Eastern universities. While working in Paris over the next year, he is available to meet with representatives of the academic community or any IFTA society to discuss appropriate tactics.

Professor Henry O. Pruden was interview by Mike Carr and appeared in the MTA Newsletter, TECHNICALLY SPEAKING , during the Fall 2004. We would like to thank Professor Henry O. Pruden, Ph. D allowing us to reprint this article.