Tuesday, September 15, 2009

Rant on Market Analysis

This is an excerpt from Monday's Quick Takes Pro newsletter.

We’ve been thinking a lot about market analysis over the past few weeks. Why has what we’ve had great success using stopped working?

Yes, we know markets evolve and we need to adapt but this is not what we mean. We know that not every chart pattern works as intended but over time, and using appropriate risk anagement, the odds of making money are pretty good. Or at least they were.

Now, we see things like a shooting star candle, complete with a confirming next day decline, lead to a new high immediately after that. Again, it happens but not day in and day out like it has this year. What about falling volume over the course of the rally and how rallies need fuel – volume – to continue?

We’ve seen technical analysis “events” that were extremely flawed just keep going as if they were textbook. The golden crosses come to mind here, as the simple average crosses should not have meant anything but then the exponential Nasdaq cross soon developed. The Nasdaq signal has a mediocre track record but then the S&P cross happened.

Then Dow Theory supposedly signals a buy but the sentiment was all wrong. It was like water torture as a parade of bad signals marched by, each flipping us the bird. Had they been bunched closer together then maybe their sum total would have been enough to provide a more classic signal by a confluence of indicators.

But no, they were spread out far and wide. What bothers us now is the lack of credibility that technical analysis – and all analysis, by the way – has developed in August and September. Sell in May? No way! Sell at resistance? No chance! (OK it was a very weak rhyme). Sell on a divergence? Forget it, we cannot even begin to rhyme that one. (Suddenly Alice Cooper lyrics come to mind.)

So what is going to happen when the signals for a true change in trend pop up? Will we notice them? Will anyone listen if we report them?

In order to cope with this we are going to have to look at different types of data generated by the market and the actions of those within. It is still the basic definition of technical analysis but we are going to have to forego chart patterns and momentum and all the other traditional trappings. This market is not trading as a fully free and fully functional market should. Not with all that liquidity being pumped in via free money at the Fed window. Not with governments stepping in to prevent capitalism from working by culling the herd of ineffective users of capital – like AIG, General Motors and the like.

So what then? Insider actions can be one way to cope. Market sentiment can be another
and we don’t mean the VIX. Indicators based on options, volume and tick are all suspect in a world where price changes are razor thin, firms front run the “book” and we have no idea if a trade was a hedge or an actual expression of bullish or bearish opinion. Did I buy a put option because I was bearish or to lay off risk of the long ETF I bought because I am bullish?

Time to end this rant but before we do we want to get across the message that we are indeed adapting to the new world order. Perhaps leapfrogging might be a better term as we are not adapting the indicators but rather we are adapting the entire concept of technical market analysis. Sorry Edwards and Magee, your time has past.

In this blog, I wrote that I thought stock trading has jumped the shark. When football coach Jimmy Johnson is touting a stock trading software package and using incorrect terminology to boot I have to believe that this industry is pulling out all the stops as it dies.

All of that money being pumped into the economy has created an overall stock market bubble once again. It is not going into the economy as jobs continue to disappear. Yeah, yeah at a slower rate but disappear they do. So where is the money going? Into stocks.

And what happens after bubbles burst? Well, you know. The problem is that bubbles can last a lot longer than we can fight them.

13 comments:

Joe said...

Hi Michael!


You just expressed my feelings and my thoughts about the markets in your article.
I feel this feeling in the last 2-3 month especially being valid.

However, to mention another analist Carl Swenlin gave his thought about this lately.

The current market is a Bull market, interpreted based on the MA200 / Price relationship and
the GRDAD MA200 directon.

If we accept that fact, than Bull market rules apply.

If that also true, than we can expect many Bearish patterns ultimatelly get resolved to the upside.

No matter how hard it is to accept in light of the current US economic strength, economic data
and the validity of those data.

It is sad that we are not living in a free market. Probably not so long.


Have a good day.


Joe

Antonio said...
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Antonio said...
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Antonio said...

After many years of successful trading, I have lost a lot of money trying to short the market in many attempts from june, so I give up. I don't understand the strange behaviour of these markets. Technical analysis doesn't work anymore; fundamental analysis is ignored; the same for statistical analysis. Never seen the last sequences of candlesticks with low volumes of stubborn uptrend. For me the liquidity argument is not sufficient to explain all of this. Maybe there is a ordered plan arranged by Fed and government to push stock market covertly also by faking official statistical data and exerting pressure on financial news media to emphasize good news and minimize bad news. Meanwhile, they hope, the economy will rebound.
So we have idiots who prevail on clever people: Jim Cramer is right and Michael Kahn is wrong!

scrow774 said...

Like Antonio, I have taken my licks since July, but have been able to remain up by scalping moves in both directions. What worries me is that since this "buy the dip" philosophy is becoming so prevalent, a large number of traders (hopefully i wont be included) are being set up to get raked across the coals. I think the key, like always, is to have stop-losses in place (i use mental stops) before any trade is entered.

By the way, I truly appreciate your thoughts and insights.

Mikey said...

Some weeks ago, I left a message saying that I found some 'traditional' signals continued to work, occasionally ...
I take that back - I'm now with you all the way ...
Michael

leocec said...

many look to TA as the holy grail to financial trading. If it were true, we would all be spectacularly wealthy by now.... That said, someone still needs to be on the other side of the trade. Given that trading is a zero sum game, on man's loss is another's gain

The fact is that since the dawn of time, man has been hardwired to search for patterns in order to survive. Understanding season changes in order to know when to sow, springs to mind for example (no pun intended). This has persisted right through to modern times and into financial markets where random events appear to have a predetermined course.

Ultimately, TA is a self-fulfilling exercise. If enough participants look for a similar outcome (such as a Fibonacci retracement) then there's a good chance that it will work as most will act in similar fashion.

It ultimately boils down to probabilities. How likely is it that a future outcome will play out. Understanding probabilities in conjunction to the timeframe of the analysis is the key to successful trading

One of the best indicators is a failed indicator signal. For example, if a sell signal fails to work you can be pretty certain that the contrary move will be powerful. Why? because most expected that contrary and are having to cover.

With successful risk management tools, technical analysis remains a powerful and only mechanism to trade the markets.

Mikey said...

Dear leocec -
I agree with your comments, but in the last 50 years I've been used to being correct around 60-70% of the time, in all sorts of market conditions - currently I'm wrong about 60-70% of the time, and Money Management doesn't make up for those odds - I'm puzzled ...
Mikey

Quick Takes Pro said...

Antonio,

Hmmm, I am not feeling so clever this year.

Quick Takes Pro said...

leo,

I agree that people look for holy grails but disagree that TA is a self-fulfilling prophecy. I think the more people that see it the WORSE it works.

However, you make some great points and while I am currently down on TA I am not out on it. We just need to look at things differently. Isn't that always the case?

Quick Takes Pro said...

Mikey,

You are not me in disguise, are you?

Subhankar said...

Can't blame Edwards and Magee. Their theories did not perceive a concerted effort by Federal Banks across the world to stymie the worst economic crisis since 1929 by printing money.

It is quite apparent that the rally is driven by liquidity and not by fundamentals. As long as the Fed's printing presses continue to churn, this rally will defy all technical signals.

In the longer term, reversion to mean will happen. Our propensity for short-term gains had created the crisis in the first place. May be it was a blessing in disguise. Many more investors will start to learn about prudence, discipline, and long term value investment.

Quick Takes Pro said...

Subhankar,

Glad to have readers from your part of the world!

You are right, we have all lost the virtue of patience. Buy and hold SHOULD work as in find a good company in a good business and let them do all the work. All this volatility and meddling made that moot.

However, I think buy and hold is going to make a comeback when the last "value" advisor finally realizes it does (did) not work - yesterday.