Thursday, September 14, 2017

Unmasking the VooDoo: Guru Calls

I originally wrote this in August 1998 when I covered technical analysis for BridgeNews to explain what a big stock bull saw in the charts to suddenly turn him bearish. The names have NOT been changed because the call turned out to be pretty darn good.

What did that mean? 

Why a big bull turned into a big bear

This week, mega-stock bull Ralph Acampora, chief technician for Prudential Securities, did something that most people on the Street thought would never happen. He issued a sell signal. Shudders went though the masses. If this guy, who was famous for predicting Dow 7000 when the Dow was 1000s of points away and who clung to his Dow 10,000 forecast for 1998 before last week's fireworks, can turn sour on stocks, what will the itchy trigger fingers of the masses do?

Let's examine what really happened from a charting standpoint. First, Acampora follows trends and patterns in stock market prices. This makes him different from that other mega-stock bull Abby Joseph Cohen, chief market strategist for Goldman Sachs, who leans more heavily on fundamental analysis. We're not going to say here which is better nor who is right. As a column that attempts to debunk the mystery associated with the Acampora side, technical analysis, we'll just focus on what Ralph saw.

There are basically two keys to his new bearish stance -- market breadth and market trends. The former measures how many stocks are going up and how many are going down. It measures how much of each day's volume is attributable to each of these two groups. In other words, is the rising tide carrying most of the boats higher? If it's not, too many of the boats have sprung leaks.

The latter concept, trend, is subject to how the stock market is sliced and diced. There are blue chip stock indices, such as the Dow Jones Industrial average, that show the "market" fairly flat over the past few months. There are indices of big stocks, such as the S&P 100, that have been rising nicely. There are indices of small stocks, such as the Russell 2000, that peaked back in April and are down 30% already. Which one of these really is the market?

The answer is that none of them on their own fit the bill. Perhaps an unweighted index, such as the Value Line Index, which gives its approximately 1800 components an equal voice, is the answer. If it is, we've been in a bear market since April.

Acampora, as well as a whole host of technicians, saw that market breadth had deteriorated badly. More stocks were going down than up. More volume was attributable to declining issues that to rising issues. More stocks were setting new 52-week lows than 52-week highs. More S&P industry groups were lagging the S&P 500 than were leading it. This is curious in that we would expect the number above to equal the number below. The industry groups together are the S&P 500.

Again, Acampora was not alone in noticing that the small stocks were going down while the big stocks were going up. Stocks with Asian exposure, such as the technology sector, were sliding since the Asian stock meltdown last autumn. True, the tech heavy NASDAQ Composite was climbing but when we examine it more closely, we see that only four stocks account for nearly half of the index's movement. That's not the market, for sure.

The 299 point sell-off we had last week was underway well before Ralph said a word. No, comments from somebody famous did not help matters but the bottom line is that the stock market was already on shaky ground.

 
Let's now look into Acampora's new downside target -- 7400. This is 1200 points away from where we are today. First, the jargon. If a correction is defined as a 10% drop, we've already had one. A bear market takes us to a 20% drop so that's where Ralph gets his wording.

Second, how did he get his 7400 number? You can bet he didn't just pull it out of his hat. The Dow 7500 level was the arguable bottom of the July 1997 - January 1998 trading range. It served as the starting point for the rally that broke free from the range and lies at one of the key percentages to which markets often fall back during declines. For those of you so inclined, it is the 38.2% Fibonacci retracement of the rally that began in late 1994.

We cannot know today whether we will see 7400. More conservative technicians will wait to see if shorter-term technical levels are violated before moving into the bearish camp. However, the moral here is that we need to question our indicators, including our definition of the market or what our advisors are saying. Market breadth and small stocks were flashing warnings a long time before the Dow got smacked.

Acampora still looks for the magic Dow 10,000 in a few months. For long-term investors, he does not sound like such as bear after all.

Friday, September 1, 2017

Unmasking the VooDoo: Fibonacci

If you ever want to sound foolish during your next television interview on the markets, tell them that the market is approaching a Fibonacci level and will do X when it gets there.  It is sort of like doing a DIY network interview and saying the house will have four bedrooms because you are using a 32 ounce hammer.

Both the hammer and Fibonacci are tools used in their respective fields. A hammer is used in carpentry to, among other things, frame a house. A Fibonacci - usually a Fibonacci retracement - is used in investment analysis to frame the market's recent move.

Obligatory definitions

Here is the section where we have to define what Fibonacci is and we'll focus on Fibonacci retracements. If you have any interest in who Mr. Fibonacci was, feel free to fire up the Google. It is irrelevant to what we are doing here.

Mr. F's claim to fame was discovering a mathematical sequence that seems to describe a lot of geometry in the real world from how petals spiral on a flower to how stars spiral in a galaxy. And from that sequence we get the "golden ratio" or "divine proportion" which somehow describes pleasing and useful relationships in art, music, architecture and design in general.

The ratio of .618 to 1 comes from a sequence of numbers where any number is the sum of the two that preceded it. Here is it in all its glory:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711, 28657, 46368, 75025, 121393, 196418, 317811, ...

As you can see, the numbers start to get huge. Fortunately, we rarely encounter any above 144.

And even more fortunate, the ratio of any two consecutive numbers settles on .618 fairly quickly. As follows:

0, 1, 0.5, 0.666667, 0.6, 0.625, 0.615385, 0.619048, 0.617647, 0.618182, 0.617978, 0.618056, 0.618026, 0.618037, 0.618033

First, this is the ratio calculated out to the number 610 in the sequence.

Second, and more important, you can see how the ratio oscillates higher and lower as it hones in on the .618 value. Any ratio beyond what is shown above is pretty much just rounding error away from that value.

Voila! the golden ratio!

Fun for math nerds
 
The ratio has all sorts of neet-o properties. For example, 1 / .618 = 1.618.

And 1 - .618 = .382.  Guess what the square root of .382 is? That's right, .618.

.382 / .618 =  .618

You have probably seen these two percentages on the charts an they are roughly equal to the simple percentages traders have used for years, namely 1/3 and 2/3 (or .333 and .667).

Guess what is not a Fibonacci number. 50% or .5.  Check out the sequence. It is nowhere to be found. And you cannot concoct it from math-ing 0, 1, and .618, either.

Still, traders do attach meaning to a 50% retracement or pullback and it has wormed its way into analysis using Fibonacci. Don't fight it, exploit it.

Using this stuff

Now is when we get to dispense with the formalities and use the name experience chart watchers use - fibos. Don't confuse this with fibbie, which is the FBI. Or fubar, which was what you may be feeling right now trying to digest all this fibo stuff.

Fire up any charting software package and under the drawing tools section you will see Fibonacci retracements and possibly Fibonacci extensions, time and arcs. They are all just different ways to look at two points on a chart - usually a high and a low - and then draw stuff off of them at specific percentages.

Take a look at this chart of the S&P 500 from 2007 to 2011. Using the basic set of fibo retracements of 38.2%, 50% and 61.8% look how nicely we could project where support and resistance might be.


Here is where you can get into trouble. These levels are likely places to find support and resistance levels but not always. And sometimes you might be tempted to add more fibo lines until you find one that fits.

My advice is to never add more percentages except for one... and it is a bizarre one. We'll get to that later.

Remember, we are only trying to frame the market, not nail all of its turns and accelerations. We'll use other tools to attack that part.

Anyway, we can see that the rally peaked at the 61.8% retracement and the ensuing correction stopped at the 38.2% retracement. Whoopee! It worked once. We can even see the market stumble in the vicinity of the 50% level.

Let's repeat this. Fibos are likely place for turns, not guarantees.  But we can beef them up a bit by measuring fibos from other points and see if they overlap, or cluster. If they do, then we have a better support or resistance target.

Check out how the rally from the 2010 pullback low to the highs of 2011 is 161.8% of the pullback itself. Something usable must be going on here.

Even better, what if moving averages hit those fibos? Or normal horizontal support or resistance? Or trendlines?

Getting the drift? As with any tool, the more things that point to a price level the more likely that price level will be important.

Now for the bizarre.  Some people use a 78.6% retracement level. Note how this is kind of close to 75% but that is not what makes it bizarre. It .786 is the square root of .618.

In my book, if a market can retrace this much of a previous trend, it is rather likely to retrace the whole thing.

The other fibo stuff

We touched on extensions, time and arcs so let's put in the quick definitions. A fibo extension is a number bigger than one and it projects where a market can go. Look for such numbers as 1.382, 1.618, 2.618, 3.618, etc.....

Draw an arc centered on the origin for each ratio (usually the original ones less than 21) to find trend targets.

And instead of measuring price, do it on the time axis. Think about looking for a 61.8% price retracement that took 61.8% of the time of the previous trend to happen. Make a fibo box out of it.

Fibos are also used in Gann and Elliott Wave analyses. For the latter, we like to see Elliott Wave 3 to be 1.618 or 2.618 the length of Wave 1.  That is a whole nother can of worms so we'll end this right here.

Use fibos on your charts but please use other things along with them. They can help you frame the market but like a hammer, you will have to decide where to put the door and windows. Fibos do not dictate where you buy and sell.

Friday, August 25, 2017

Unmasking the VooDoo: Sentiment


Usually, when I discuss the major parts of technical analysis I'll use an analogy of a table. Price is the top of the table and the most important part. The legs are volume, time and sentiment. They support price analysis but do not supplant it.

Everyone gets price from patterns to trends to momentum. Everyone get volume. Most people get the concept of time, too, which includes such things as cycles, analogs and some esoteric stuff such as Gann.

But sentiment is often the red-headed stepchild of the analysis. Sentiment is hard to gauge. It is hard to quantify. And it is usually fairly hard to gather. Just look at your charting software list of studies. You'll see RSI and cumulative volume. You might even see an Elliott Wave "recognizer" but you are not likely to see something called sentiment.

These things do exist but they are not derived from trading as all the other parts of the table. Sentiment is the true oddball of technical analysis because it is the only analysis that seeks to figure out what traders are thinking. It's not like everyone inputs their feelings into an app on their screens and sends it off for tabulation at a vendor.

Yes, I know there are surveys that do just that but for every collector of sentiment there is a different method and interpretation.

And there are many, many different types of surveys and proprietary indices. There are surveys of traders, of investors, of newsletter writers. Then there are surveys of the actions of traders, which are different from surveys of what traders think. There are surveys of money managers and of Wall Street strategist equity allocations.

There are a few oddball things such as the trend of carpenter tool prices and railroad car usage. Most people may have heard of the trend in oil rig counts.

Have you heard of the hemline indicator? They get shorter when people feel feisty and good.

How about the magazine cover indicator? This is a real thing and it is actually pretty good.

The ratio of football revenue to baseball revenue? Football is a darker sport. Baseball seems to do well when people are happy. Just ask George Carlin what he thinks about these two.

How about horror movies vs. romantic comedies? Same logic.

Giving credit where it is due, those last two come from socionomics, which looks at social mood as an indicator of the stock market. It actually works in reverse but they are closely enough correlated for this discussion.

And if that were not enough, there are a few things that are generated from trading including the famous VIX index, which is concocted from options prices. There is the ratio of puts to calls. Of put volume to call volume. Of equity only puts and calls. Of index puts and calls.

I supposed if we go there it is not far to include the number of stocks above their 200-day averages and at new 52-week highs or lows.

Have I convinced you that sentiment is wild and whacky? And hard to quantify? And hard to even obtain the data?

Using Sentiment

Let's assume you have access to some sentiment data or perhaps just have eyes and ears to follow the news.  What do you do with it?

First of all you have to understand that sentiment is a contrary indicator. And most of the time it tells you nothing useful. If the market is going up then sentiment should be happy.

It is similar to the trend is your friend until the end. Most of the time, the crowd is actually right and you follow along. Only at the extremes is it wrong and you need to go against it. You know, buy when there is blood in the streets. Sell when E*Trade runs ads with cab drivers buying islands. Or when the local pizza shop owner brags about how many houses he flipped.

Remember way back to 2008 when the market was going to hell in a hand basket? It was a brutal bear market and the government was panicking to do something - anything - to look like they were able to stem the tide. My father-in-law, rest his soul, called me to sell everything in his portfolio. I sold a little so he would not be mad at me but I kept the rest.

When the public gets so scared that they throw in the towel you know sentiment is at an extreme for bearishness. In fact, the American Association of Individual Investors survey was at a record high for bearishness. Something like 70% vs. its historical 28% (I am just going from memory on those stats).

Take a look at what was on the cover of Time Magazine on March 9, 2009. It said the economy was holding on for dear life. it talked about foreclosures, about nationalizing banks, toxic mortgages and your disappearing savings.

Guess what day saw the absolute lowest close on the Standard & Poor's 500 index? That's right March, 9 2009. It nailed the bottom.

Usually, there is a lag in these things so don't obsess over this perfection.

Why does this work? When editors or general interest media take the pulse of their readers and finally believe that readers want to read this stuff then we know sentiment is very one sided.  You may rag on Barron's covers but Barron's is not general interest. It's covers are driven by professional sentiment, not the general public.

The same thing works at tops. Think tulip bulbs. Bitcoin. And right now, some think Amazon.com. None of these markets, save for Amazon, had any connection with the real world. They were the greater fool, burning match theory in motion. They went up because of FOMO. You didn't think I could schtup in a millennial reference, did you - fear of missing out. Go buy some etherium. YOLO.

When an actual survey goes extreme, you can bet that whatever trend was in place is nearing its end. But remember, sentiment is not a trading trigger. It sets the environment for that trigger to be really meaningful.

If you can find a stock with a reversal pattern or some other technical positive in place and sentiment is awful - like SNAP was in mid-August - it might be ripe for at least a trade if not investment. Likewise, when all the Amazon haters finally acquiesce (i.e. shut up) then we can consider the stock is too high.

Friday, August 11, 2017

Unmasking the VooDoo: Moving Averages


As with all technical indicators, moving averages are just tools chartists use to figure out what they need to do in the markets. Notice I said they are figuring out their own actions, not divining where the market is going. Of course, the two are related but that is not the point.

What is the point is that pundits and journalists like to report when the market breaks one of the more widely followed moving averages. In this edition of Unmasking I am going to take a look at what a move through an average - or a "crossover" - really means.

Let's start with just what a moving average is. If you want the full definition feel free to fire up the google, the bing or even (shudder) the yahoo. And if you know what a moving average is, feel free to skip the next two paragraphs.


A moving average, or average, is just an mean price over a certain period of time. A 50-day average is the sum of all prices - usually the close prices - divided by 50.  Easy peasy.  Since the calculation is redone fresh each period, the value window of data "moves" over time. Get it? Moving average!


Yes, we can change the span, period, input type and even the weighting of the calculation using any number of oddball formulas but again, if you want to learn about that, it's back to the google for you.

So what is the big deal with these things? Do they create trade triggers? Which ones do we use?

To answer the last two questions: maybe and whatever floats your boat. Yeah, not much help but these are answers you need to develop on your own. I'll just tell you what I do with them.

And to the first question, the big deal is that they help us see the forest for the trees. They smooth out jumpy price action to let you see the major and minor trends. You change the parameters depending on what you are trying to do.

You do realize that the government actually uses a moving average on some of its big monthly economic reports, right? Why? They say it smooths things out. Score one for the chartists.

You can use averages in pairs or even triplets, garnering insights as the averages dance around each other and with the price plot. But let's KISS (keep it simple, schmegegge).

Let's talk about the 50-day moving average. Yesterday, August 10, 2017, the S&P 500 and Nasdaq both closed below their 50-day averages for the first time since July (June for the Naz). The financial headlines were quick to point that out and with the news of the day - a potential nuke crisis in North Korea - boy did they make a big deal. Gotta build the click through count.

Chicken Little was ready to sell everything and head for the hills. Now, can we take a peak at the headline from July 6, 2017 when the S&P 500 last closed below this red line in the sand?
July 6 - Nasdaq challenges major support amid geopolitical tensions, S&P 500 nails 50-day average
In the words of  that famous portfolio manager Homer Simpson, "Doh!"

Six days later, the Spoos reached another new all-time high. Talk about a crappy sell signal!

Let's look at the charts. As you can see, price action violated the average on four separate occasions before the current event since the November pre-election low. The 50-day average did not deliver a successful sell signal one time. None. Zilch.



That does not mean that a drop below the average is always meaningless but I'd rather look for something more reliable, such as a support break, to tell me to sell. Rather, I'd use breaks of the average to set up or confirm other signals.

So again, what is the point? The point is that averages help us figure out the trend. Just look at their name - average. Let's expand the chart all the way back to the start of the major rally in early 2016.


I added the trend channel with a little technician's license to make the upper line more meaningful. That means it touches price action more times.

Look at the 50-day average. It more or less runs through the middle of the channel. Price goes above and below it yet it still was a bull market. The average itself spent most of the time rising.

The next question about that time when it was not rising naturally will be, "How do you know it will go back up?" Well, you don't but there are other tools to use, such as the popular 200-day average and any number of indicators.

The point is that in a bull market being above the average is good but being below it is not necessarily bad. In a bear market, being below is good (for the bears) but being above is not necessarily bad (for the bears).

So, slap on your averages, short-, medium- or long-term, simple, exponential or VIDYA, and find out what the current trend is. However, selling just because price dipped below your average is not always a good idea.

Tuesday, July 18, 2017

Millennial Breakdown

I've written sporadically about how the new generation (I guess I am now in senior citizen territory) cannot do simple tasks that we boomers take for granted. Where does the postage stamp go on the envelope? How do I fold the New York Times to read on the train?

I blogged a similar topic here in March 2017.
(http://quicktakespro.blogspot.com/2017/03/the-coming-crash-of-internet.html)

Remember way back when...in school you had to learn basic math even though you had that nice Texas Instruments calculator? I never got the hang of that one but my Casio with none of the fancy functions worked just fine. Who did not enter 01134 and turn it upside down so it says hEll0?

But I digress, as I always do. The point was that you needed to have some math skills to really understand what the calculator was doing. Does the answer makes sense? Did I hit + instead of -? You get the point.

You need map skills to know that blindly following google map directions can get you stuck in rush hour traffic in the heart of downtown Manhattan instead of taking a better route. I also mentioned that last March.

So, even though you do everything by email there will be the odd time when your water bill must be mailed to the utility because they do not take credit cards. You need to know where to put the stamp.

I admit to clinging to the old ways of having a little cash in my pocket and planning my travels in advance. Here is the story. My 22-year old daughter flew back to NY to spend the weekend with friends and of course visit us. She ended up at a friend's summer house in the boondocks of Northern New Jersey and needed to get herself back to us on Long Island Sunday morning. No problem, right?

She asked me for help picking a bus to NYC. How should I know? She finally figured out where the bus was but she had to get there. Did her friends wake up early to drive her? Of course not. But no problem! Uber!

Well, let's say there is not much coverage in the NJ boonies early on a Sunday morning.

Long story, short, I would have know exactly how I was getting back to the city to catch a Long Island bound train on time before I even left for Jersey. I do not expect all of my needs, whether travel or food or even sunscreen, to be waiting on demand in real time for when I summon them.

The bottom line is she waited for her friends to drive back to NYC. Oh, and they did not even drop her off at Penn Station. She had to take the subway.

Millenials are so much more sophisticated than I ever was but they are helpless in the face of any glitch. They are so much smarter than I am yet who gets the call when things go wrong?

OK, I'm done. Where's my prune juice?

And get off my lawn.



Tuesday, July 4, 2017

The Fallacy of Analogs

One of the key tenets of technical analysis is that we can use previous patterns to forecast what might happen in the future. It is not the same easy modeling of fractals  (please tell me you get the sarcasm). We cannot build the big picture from a lot of little pictures as we can with snowflakes, coast lines and galaxies. And if you think that patterns are self fulfilling prophesies, please stop reading now and navigate to Ihaveaclosedmind.com.

Patterns do not predict the future. They give us a better probability of a future outcome because people act in similar ways when faced with similar situations. You get to define what is similar.

Note the liberal use of the term "similar." Also note the term "probability."  If these things worked perfectly as expected then there would be no market.Who would take the other side of an upside pattern breakout if the probability were 100% that the market would rally? That little level of uncertainty allows bulls and bears to place their bets, manage positions and even operate in different time frames.

Now that I've established that patterns work, at least with a decent enough probability to make correct calls, let's look at two patterns together. These are called analogs and they are used to find similar behavior in the past so we can forecast what will happen in the future. Or, patterns in one market vs. another, including a commodity and stocks that gather that commodity.

Who has not found patterns in the Dow that look a lot like the one in place in 1929 just ahead of the crash? Who has not compared the tech bubble to the housing bubble? You get my drift.

Sometimes these analogs are useful (asterisk). But sometimes they look great until you realize you've stumbled upon coincidence?

Check out this overlay of bitcoin and the Nasdaq-100 for a recent six-month period. Both markets were soaring. Super performing FANG stocks (the acronym for the go-go technology names) drove the Nasdaq-100 to dizzying heights. And bitcoin, the new crypto-currency was making different but equally as powerful waves as the next great thing. It kind of made sense that these two world changing markets looked the same.


Sure, there are a few times one zigged while the other zagged but overall they tracked each other quite nicely.  Therefore, as I write this and the tech sector is getting somewhat hammered in what the bulls hope is the long-awaited correction we can excuse bitcoin's recent weakness. When one turns up, it should signal time to buy the other, too.

Of course, this was a fairly small set of data so let's go back a but farther to see if things still look as good.


This chart shows about twice the span of the first and it is still not too bad. The July 2016 period was a big headache and January 2016 was even worse. However, nobody would argue that they two plots still looked rather similar.  Damn! We got something here!

Um, no.

Bitcoin spent all of 2014 falling while the Nadsaq-100 had another spectacular year.

In statistics, most people find a relationship using one span of data and then test that relationship using a completely independent set of data. The second set is called "out of sample" and it is important to make the case that some theory works all, or at least most, of the time. Testing on data used to create the theory is like eating your own cooking. You may like it but everyone else heads to the vomitorium.

Fun fact - Although we use it for dramatic effect, a vomitorium is not a place to puke after over indulging. It was one of a series of entrance or exit passages in an ancient Roman theater. It means "to spew forth" and they were designed to provide rapid egress for large crowds at amphitheatres and stadiums. Think about that as you head home from the ball park.

Getting back to the topic, there is no analog here. It was coincidence. You know, correlation does not imply causation. Yeah, I don't like that phrase, either.

Then why do we look at them? Perhaps for the same reason we see a man in the moon. We are programmed as humans to look for order where there might not be any. I think it is some primitive survival thing but I'll let you look that one up.

And now for the asterisk. Did you miss it? It was in the fifth paragraph and above the first chart.

Why are these analogs useful at all? My take is that they give us two charts to analyze for support, resistance, trend and pattern at the same time. Then again, you could analyze them completely separately and still find the same support, resistance, trend, pattern and eight-by-ten color glossy photographs with circles and arrows and a paragraph on the back of each one. 

Never miss a chance to quote Alice's Restaurant. 

Ending on a serious note, stocks and bonds sometimes move together and sometimes they move opposite from each other. Sometimes they compete for investor dollars and sometimes they are risk-on vs. risk-off proxies. The real challenge is knowing which condition is in place sooner rather than later. Is it an inflationary environment or deflationary? Is the economy this or the dollar that? Are we in the old economy or new? Oil or natural gas or solar? Etcetera ad nauseum.

I do not completely dismiss analogs for use in the big picture. I also would use them as I use regular chart patterns in the probability assessment task. However, thinking one market will dictate the fortunes of another is folly. Pure price analysis of the market you trade is still the best way to figure out what you are going to do. Buy, sell or hold. After you show how smart you are with equations, speeches and theorems, it all boils down to what you do. That is the whole point of any analysis.

(charts courtesy of TradingView)

Sunday, June 25, 2017

Unmasking the VooDoo - Head-and-Shoulders

Whenever I think about the famous - or infamous - head-and-shoulders pattern from the world of chart reading I always seem to go back to the late, great Mark Haines of CNBC who in the summer of 2009 asked every guest, whether they were a technical analyst or not, if they were worried about the head-and-shoulders pattern that formed in the market. I cannot remember if he was looking at the Dow or the Spoos but that is far too picky for this episode.

Anyway, what he saw was this:


It sure looked like a head-and-shoulders, which as "everyone knows" is a reversal pattern. Keep in mind the environment we were in at the time. The Internet bubble popped and the raging bear market was only three or so months in the rear-view mirror. That is, for the few who recognized that it was actually over.

Haines and countless others were still in panic mode and in extremely skeptical of any rebound. Therefore, a possible reversal pattern was looming to squash investors one more time.

I also have to give Mark credit for recognizing the pattern with it variation of a left shoulder but we'll get more into the details of the pattern a little later.

Anyway, let's see what happened after the gentlemanly freak out on television:


Oh snap! What the heck happened? The world's most recognized pattern (by non technical analysts) failed to end the rebound. And the market went up - a lot. And fast. Hokey Smokes! (Think Rocket J. Squirrel).

Let's dig into the deets, starting with what exactly a head-and-shoulders (H/S) is supposed to be.

While the pattern works in bull and bear trends, albeit it must be upside down for the latter, let's stick to everyone's favorite - the rising trend.  

As we know, as trends trend they usually exhibit a bit of ebb and flow. Advance and pullback. Three steps forward and one step back.  You get the picture. It is good when each push up makes a higher high and each fall back makes a higher low.  

The fun happens when one of those pullbacks does not make a higher low. It can make the same low as the previous low or (shudder) it can make a slightly lower low. 

Fortunately, the market or stock or commodity or bitcoin heads back up.....but cannot get back to the previous high. What we have here is a warning. And dollars to doughnuts I bet that momentum readings or volume or some other indicator makes a lower high, as well. Actually, I'll bet it made a lower high when price made a higher high, too.

The trend may be in trouble here. But is it a reversal pattern? Well, not yet.  What has to happen to complete the H/S is a lower low below the level of the previous low, or in most cases the previous two lows since they were the roughly equal. 

What may also happen at the same time is a breakdown through a significant moving average, perhaps the 50-day.  And depending on how long the trend has been in place, we may also see a breakdown below the trendline that guided the rally the whole time.

You would think that would make a compelling argument, right? And it does.

But in technical analysis everything us open for discussion. Everything. A rally can turn around without any warning at all. A stock can break out from a trading range and then break down and then break out again. We operate with the odds, not with crystal balls. Iron, maybe but never crystal.

If the odds that a stock will rally after a solid breakout from a solid pattern are 95% (I made that up) that still leaves room for failure. It is our job as chart readers to recognize failure sooner rather than later, cut losses and live to trade another day. 
Nobody gets it like they want it to be
Nobody hands you any guarantee
- Jackson Browne, Boulevard (1980)

As we can see in the second chart, the market did indeed break down from the H/S pattern. I bet the folks at CNBC were pulling spare tighty whities out of their desk drawers. 

But the darnedest thing happened. The market turned right around and started to move higher - for the next seven months with nary a hiccup. Talk about damaging your shorts!

I saw two things back then. First, basic risk control and common sense said that four trading days after the breakdown - when the market surged higher and back above the broken support line - aka the neck line - the whole reversal thing was destroyed. And if you missed that signal, certainly you abandoned your short trade two days later when the market surged again. 

If you did not see that then you really should just give Vanguard a call and let Bogle manage your stash. 

The sentiment thing was a bit trickier. People were still crazy bearish or at least crazy nervous. And the publicity given this pattern seemed rather panicky. What a lot of people don't get is that sentiment - at its extremes - tells you exactly the opposite of what is likely to happen. If everyone is bearish then there is nobody left to get bearish. There will be nobody left to sell since theoretically everyone has already sold. Supply dries up.

It's like dry kindling just waiting for a spark of demand to appear to light things up/

Sorry, got off track with a discussion of supply and demand in the markets. Anyway, the breakdown failed and everyone came rushing back in to buy.  Up, up and away!

 Let's examine the H/S pattern in 2009 a little closer: 

The pattern is supposed to be a reversal pattern and therefore it must have a trend to reverse. Typically, I like to see it last no more than one third of the time the trend lasted before the pattern started. And, I don't want it to be more than a third of the price gain of the rally.

If the H/S pattern exceeds either of these two parameters it is not a H/S reversal pattern. It may look like it but it is far too big on a relative basis so it must be something else. It may send the market lower but that's not the point. We are examining the specific head-and-shoulders pattern here. 

What we see here is that the H/S pattern was about a third of the height of the rally that preceded it. I used the Fibonacci extension ratio to get 38.2% (almost). That's close enough for me. 

However, when we get to time the patterns falls apart. The rally lasted 40 days before the pattern and you are correct, we cannot tell that until well into the pattern's development. 

The next 40-day mark is drawn in for your viewing pleasure. As we can see, the pattern lasted longer than the rally it was supposed to reverse. that means it really cannot be a reversal pattern at all. Again, it may lead to lower prices but that would be due to a simple support break. 

Well, there you have it. The H/S pattern must be commensurate with the rally it is supposed to be reversing. Sentiment was a bonus here.

And what about falling trends? Just flip the whole flipping thing upside down. Same rules apply.  We can that an inverted head-and-shoulders. Or, you can call it an upside down head-and-shoulders. Or, you can call it Ray, or you can call it Jay but you doesn't hasta call it Johnson (yeah, look up that pop culture reference). 

And now, for the pièce de résistance - the inverse or continuation head-and-shoulders. 

Nah, I lied. I'll save that for another day but here's a tip, the same rules apply in terms of price and time. 

Nothing is more bullish than a failed bearish signal.
- Mike Epstein

Friday, March 31, 2017

Unmasking the Voodoo - Cup with Handle

Anyone who ever discovered a relationship in the stock market and decided to go public with it probably created an indicator - which they named after themselves - or described a pattern or cycle and gave it a really catchy name. I want to focus on the latter in this post.

First of all, let's start with marketing. Ralph's OK Chart Pattern is not going to sell a lot of technical analysis books. It won't get a lot of page reads online. And it won't be worth anyone's while to publish it without the advertising potential. Forget about seeing it coded into TradeStation.

It does not matter if it works or not. Or even if it really works. I mean reeeaallllly works all the time and makes oodles of coin to impress the ladies (or gents, I don't judge).  The only way someone will care about Ralph's OK Chart Pattern is if they 1) find out about it at Ralph's OK workshop at Traders Expo or 2) find out about via a catchy headline such as "Ralph has unlocked the secret of the market with a chart pattern that works every time with no draw downs!"

OK, that's extreme. But what if Ralph's pattern had a better name? One that is easy to remember. And one that cuts through the clutter of every other Ralph out there with his own pattern?

To me, cup-with-handle is just a perfect name. First, you can visualize it even without a chart. Second, it actually describes what you see. And third, there is actual technical analysis behind it.

Of course, a lot of people seem to forget that last part.

There really is a some theory behind the picture but why let that get in the way of a good forecast?

Back in the day when William O'Neil concocted it, the cup-with-handle was a bullish continuation pattern that formed over a period of three-six months.

Let's dissect that definition. First, it is a bullish pattern in an uptrend. Nowhere does it say it works in a down trend although we technicians like to think every pattern works in all markets and in all time frames. For sure, some do but not all. In the stock market, and that is where the pattern was developed, up trend and down trends have very different personalities.

Next, nowhere does it say that the cup-with-handle is a reversal pattern. It says it is a consolidation in an uptrend. It did not say it was bullish no matter what.

Now, that does not mean there cannot be a similarly shaped pattern at the end of a bear trend that reverses the market to the upside. It's just not a cup-with-handle.

Now, I just pooh-poohed the notion that the pattern only works in a three to six month period. If you really understand what is going on then you will see that it does translate to other time frames - barely. The built in technicals of support, volume and consolidation do apply across time frames. But again, can we call it a true cup-with-handle?  Going by the definition handed down by the creator at the IBD alter it is not a true cup-with-handle.

OK, that's picky. But the part about it being a bullish consolidation pattern in an uptrend is untouchable.

Now it is time to get into the pattern so you know what you are talking about - in a way people can and want to understand - the next time you get interviewed on the Consumer News and Business Channel. Yeah, that's CNBC.
Nerd Note: Originally established on April 17, 1989 by a joint venture between NBC and Cablevision as the Consumer News and Business Channel, the network later acquired its main competitor, the Financial News Network, in 1991. Cablevision later sold its stake to NBC (Wikipedia).
Sorry, I am still kicking myself for turning down a gig with them back then.

Anyway, the cup-with-handle describes what happens after a rally. The stock eases back down on diminishing volume. Endures a period of low volume, low volatility trading. Starts to recover as volume picks up before finally erasing the whole decline.

If you want a chart, visit with my little friend Google. or be wild, try Lycos, Hotbot, Ask or Webcrawler. OK, you can try Yahoo, too.

Now, at resistance from the old high the stock pauses again.

Think about this for a moment. In any pattern, a pause at resistance gives bulls and bears a chance to think about life without having to trade. In most patterns, price action touches resistance or the upper border of the pattern a few times. Why? Supply overwhelmed demand at that relatively high price.

Sometimes a stock will slice right on through resistance immediately after bouncing off support. This sort of breakout - usually due to momentum - is not reliable. I'd rather see everyone calm down at resistance so that a breakout attempt results when there is a sea change of attitude. What was once relatively expensive suddenly becomes relatively cheap. That's a true breakout.

It could be a product launch, the CEO finally clearing that intestinal blockage or some other mood bending occurrence from the Fed, oil prices or Gollum. It does not matter why on the charts.

The charts tell us that something changed. Knowing exactly what does not make us any money. Taking action does (or should).

Picking up where we left off, we have a stock that rallied, pulled back in a defined manner to really allow all excesses to be wring out and then a pause back at the old high. Remember, we like pauses at resistance as good setups.

Then the stock eases back a bit. Aye, a bit. It's subjective but if it looks small relative to the overall pattern then that is ease-y enough for me.

What is that important? Because it tells us that bulls were mostly holding on to their shares. A lack of buying rather than heavy selling caused the small price decline. How do we know? Because volume eased back with it.

You might recognize that as a flag pattern elsewhere.

The fun comes when the small pullback is resolved to the upside. Another sea change towards the bullish side and away we go!

And if the pause keeps going and either a lot of time passes (like months) or price sags too much then there is no breakout and no buy signal.  Just as with any other technical chart pattern.

Sure, you can describe the pattern with what unfolds on the chart but the voodoo-less way would be to talk about why the ups and downs appear:
  1. A stock rallies
  2. It reaches a point where the price entices supply to appear and demand to wane.
  3. That creates a pullback as bulls lock in profits.
  4. Then the market loses interest and the stock languishes for a while.
  5. But since the stock was bullish only a few weeks ago some people decide to buy it on sale.
  6. They tell two friends and they tell two friends and before you know it the stock slowly recovered.
  7. That was not lost on the bears and the other nattering nabobs who see another chance to sell at the old highs.
  8. Once again, the stock eases back but not too much because not too much supply came out.
  9. Something sparks the next breakout and suddenly what was expensive is now considered cheap.
  10. Bulls pile in and volume increases.
  11. The stock rallies again. 
Note how some of that is silly for a stock in a down trend. The premise that the stock is generally a long-term winner is important in the intermediate-term gyrations.

When you know why a pattern forms you will understand what the market is telling you when it happens.

And one more thing - the cup portion has to look like a cup. It cannot be a sharp reversal with a champagne class. That leaves no time for the market to forget about it. And it cannot be an overly long period of malaise with a fancy soup dish. A quiet stock is not a dead stock.

It has to be a U-shaped cup with low volume in the middle.  It has to let the volume curve play out, too.

Let me live 'neath your spell
Do do that voodoo that you do so well
'Cause you do something to me
That nobody else could do
- Frank Sinatra

Tuesday, March 28, 2017

Unmasking the Voodoo of Chart Reading

Did I just call chart reading - and technical analysis - voodoo? Me, a Chartered Market Technician with the letters CMT on my business card? Me, a technical analyst who writes a column called "Getting Technical" for the past 16 years?

Well, the way everyone uses it does seem to be voodoo. And even more so when one of us gets on TV and starts talking about indicators. Even my eyes glaze over when they chatter on about RSI and moving averages did this or that so you should buy (or sell).

I'll forgive the former NFL coach who was hired to sell a technical analysis trading course and called one of them the 200 moving day average. Come on, TA nerds, you get it?

Recently, I needed to justify my analysis to a media outlet that does zero technical analysis and more likely thinks it is garbage. I basically said that you don't buy because two lines crossed. Rather, the two lines crossing is the market telling us conditions have changed and now the odds have shifted in favor of being long.

It's not the lines crossing that means buy. It is the other way around. The market is trying to tell is it is OK to give it a go so the lines crossed. Think of it as the spirit's manifestation on the screen.

We've all seen stories about the market about to tank because the S&P 500 just formed a black or death cross on its chart. Within days, the index is higher than it was at the time of the cross so the hate mail starts to flow. But let's look at it the other way and it will make perfect sense.

First of all, the death cross occurs when the trend has already changed. That is the only way the math works, by the way, because the pattern is defined as the 50-day moving average crossing below the 200-day moving average. That cannot happen when prices are rising.

Anyway, in practice we often see the market bounce right as the cross happens. Why? Because typically it has been falling for a while already. Again, is has to be falling otherwise the short-term average cannot drop under the long-term average.

OK, Einsteins, I know we can make the math work with price spikes and outliers but roll with me here.

So, the market may be a bit oversold and it bounces. But overall the cross appeared because most likely something is wrong. Short of real voodoo telling us what's what that is all we can hope from charts. They do not tell us what will happen. They are meant to give us clues as to what to do.

Rinse, repeat.

Charts do not forecast the future. They suggest that it is time to take an action.

You don't sell when the market is overbought. It may still be going up and will get more overbought. But you pay attention because if the market does start to succumb to supply, the indicator - whatever told you it was overbought - will back down by a certain amount.

The most bullish thing a market can do is get overbought and stay that way. 
- Alan Shaw (ret.) , Smith Barney

And as we have to say with any indicator, none work in a vacuum. We need several to really understand what the market is telling us. Plus, we have to understand that it is only telling us its condition, not what it is going to do. That part is up to us.

Charts are tools, not your momma. You have to make the decision for yourself and at no time will you (or should you) think you have certainty. You are playing the odds. And all you can do is control what you do - buy, sell or hold.

Thursday, March 2, 2017

The Coming Crash of the Internet

(only Baby Boomers will survive)

A recent incident with my cell phone got me thinking once again how we rely far too much on technology.  This happened after a discussion I had with a younger friend who showed me his supermarket and Dunkin Donuts rewards cards on his phone. He is no millennial. He has a fairly high up job in his financial department so he is not a slave to technology as perhaps a kid right out of college.

I said that he could lose his phone. He said I could lose my wallet, where I keep a few of those rewards cards. I said wallets don't explode and they don't run out of battery. There is the link back to my original statement above.

He said he carries a spare battery. I said I did too but my phone ate up the juice faster than the battery could put it back. I think you get the picture.

Don't get me wrong, it is great to swipe a card or even hold a card up to a reader. Who needs cash, save for the few bucks to tip the valet...unless they take Apple Pay of course. I like that you can have dozens of rewards cards at your fingertips. I like not worrying about forgetting a paper boarding pass or coupon for $5 off an oil change.  I also appreciate having a kindle loaded with a years' worth of commuting and beach chair reading. 

Of course, if I forget my reading glasses....but that is another issue.

My problem is relying on technology. That is different than using technology to enhance my life and make it easier. My favorite story is about my son and his friends driving from Long Island to Great Adventure theme park in New Jersey. They plugged in the location on the GPS and away they went. But where did it route them? Right through the Midtown tunnel into Manhattan in the middle of a work day. There was no questioning the route. Worse, there was no ability to question the route.

Dad, this thing wants to take us though the city. Is that a good idea?

The biggest worry I have by far is that the infrastructure for all of these websites, smart phones and Internet of Things (IoT) is vulnerable. Maybe to hackers, maybe to terrorists, maybe to unscrupulous politicians. Or maybe to just simple technological failure. Just how much information can you jam into a pipe?

A constipated Internet may be decades away. An exploding web may be even farther away. And even worse, a self-aware Internet may be somewhere out there. Maybe Skynet from the terminator movies is not that far fetched.  I wonder if there is a Simpsons episode on that. They seem to be able to predict the future.

My issue is that relying too heavily on technology leaves us vulnerable to problems. I am not saying to avoid progress, only to be able to survive at least a while if something goes awry.  To this day, I still am glad I have DOS skills to help get around problems on my Windows computer. I can also read a paper map. And write with a pen. And walk. And call a restaurant for take out. And call around to find a good movie. And deposit a paycheck with a living bank teller.  And play non-Madden football with the guys.

Technophobe? Hardly. I am blogging right now. My income is derived 100% online. And I even Venmo money to my kids. I just worry that advancement will cause everyone's life skills muscles to atrophy.  Which reminds me, I have to drive to the gym to grab a little exeercise. Wii sports does not quite get that job done.