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.