buy when expectation is high, and sell when it is low. Chapter 2 explains this
expectation concept and how to measure it. It is my first pillar for successful
trading.
The second thing to look for when diagnosing a stock is its symptoms.
Today’s technical analysis is still performed at the level of the symptoms:
Traders like to catch trends and their reversals, they will look for overbought
and oversold situations, they will search for crowd movements,
they will examine the demand/supply equilibrium, and so on. These traders
are like doctors who look at a fever and know that after a few days the fever
should dissipate. These traditional analysis tools are very useful if you master
the art of interpreting them. Traders, like doctors, need a fair amount
of experience to become truly skilled. Only then will they be able to see in
the charts where a market or an individual stock is heading.
These traditional tools require skills, training, and thinking. The great
majority of traders use these tools with end-of-day data and react in unison
during the following trading session. The “doctors” will see similar symptoms
and will prescribe similar treatments (though this is not always the
case). I also use these traditional technical analysis tools, because it is critical
to see what others see to know where the technical analysis will push
the crowd of traders.
A doctor who has a doubt about a patient’s diagnosis will order a blood
sample to be analyzed; the doctor can then diagnose the disease and prescribe
the necessary medicine.
Now, suppose that it were possible for a doctor to insert a tiny microscope
inside the patient’s body, and that this microscope had a wireless
communication with the doctor’s health monitoring station. The doctor
could then monitor the fever not only after it appears (when the
patient has already become sick), but before the fever appears, by monitoring
any conditional change occurring at the microscopic level. The doctor
could sort those changes and take into consideration only those that might
cause a fever. Of course, this capability doesn’t yet exist in medicine. Similarly,
what is lacking in today’s technical analysis is a way to detect micro
changes that are strong enough to propagate over time into a full-blown
sickness.
A very useful tool that I present in this book therefore allows traders to
reach what might be called the cell level. Going down to the cell level does
not necessarily mean analyzing each transaction, looking over the trading
book size, or studying all the coming orders. You need to look at the microbes
through your microscope, but remember that you are more interested
in seeing their propagation than their mere existence. When Pasteur
discovered microorganisms such as viruses and bacteria, it was not finding
out they existed that revolutionized medicine but rather the interpretation
of how these organisms work. This interpretation led the way to vaccines
that changed our everyday life.
I love the work of Russian Nobel Prize winner Dr. Ilya Prigogine and his
theories of dissipative structures. I have to confess that it was when I was
looking for a way to discover a new tool that I remembered my readings
of Prigogine during my student days. Although these theories would not
apply to understanding how the stock market works, I found the principles
strikingly close to how I believe the stock market functions. The work of
Dr. Prigogine states that the dissipation of matter or energy is usually
linked to the ideas of efficiency loss and to the evolution toward a larger
disorder. However, far from the equilibrium of a structure, the dissipation
could be at the origin of new states of matter. In short, life was created
by dissipation that brought a system far from the equilibrium and forced it
into a new state of order. Prigogine states: