no ability to distinguish actual from counterfeit data. The true historical
prices are represented by charts b,d,e, and h, while the computer-gener-
ated data are charts a,c,f, and g.^6
TRENDING MARKETS AND PRICE REVERSALS
Despite the fact that many “trends” are in fact the result of the totally
random movement of stock prices, many traders will not invest against
a trend that they believe they have identified. Two of the most well-
known sayings of market timers are “Make the trend your friend” and
“Trust the thrust.”
Martin Zweig, a well-known market timer who uses fundamental
and technical variables to forecast market trends, has forcefully stated: “I
can’t overemphasize the importance of staying with the trend of the
market, being in gear with the tape, and not fighting the major move-
ments. Fighting the tape is an open invitation to disaster.”^7
When a trend appears established, technical analysts draw channels
that enclose the path of stock prices. A channel encloses the upper and
lower bounds within which the market has traded. The lower bound of
a channel is frequently called a support level, and the upper bound are-
sistance level. When the market breaks the bounds of the channel, a large
market move often follows.
The very fact that many traders believe in the importance of trends
can induce behavior that makes trend following so popular. While the
trend is intact, traders sell when prices reach the upper end of the chan-
nel and buy when they reach the lower end, attempting to take advan-
tage of the apparent back-and-forth motion of stock prices. If the trend
line is broken, many of these traders will reverse their positions: buying
if the market penetrates the top of the trend line or selling if it falls
through the bottom. This behavior often accelerates the movement of
stock prices and reinforces the importance of the trend.
Options trading by trend followers reinforces the behavior of
market timers. When the market is trading within a channel, traders
will sell put and call options at strike prices that represent the lower and
upper bounds of the channel. As long as the market remains within the
channel, these speculators collect premiums as the options expire
worthless.
294 PART 4 Stock Fluctuations in the Short Run
(^6) Figure 17-1b covers February 15 to July 1, 1991; Figure 17-1e covers January 15 to June 1, 1992; and
Figure 17-1h from June 15 to November 1, 1990.
(^7) Martin Zweig, Winning on Wall Street, New York: Warner Books, 1990, p. 121.