I feel like I need to qualify this post somewhat so some of my investing friends will still be friends with me. :) I take the view that almost any way of looking at the markets can be a tool at the right point in time. You don't want to be the carpenter that every problem looks like a nail and so you only reach for a hammer when you need a calculator.
Technical analysis in and of itself should be worthless. The reason it means something is because people believe it means something and there is big money at the margin that is managed following its principals on Wall St. Those more philosophical will argue that it is important because it falls into the patterns and math found in all areas of life from dimensions of tree trunks to how birds fly.
Whatever the reason, I really only find technical analysis useful in bear markets and a year ago never looked at it at. The last time I spent a decent amount of time looking at it is back in 2001 and 2002. I find it a useful tool in bear markets. The reason is because correlations of stock prices often go to 1 in bear markets regardless of what fundamentals are. In a bull market, in normal times, stocks usually react on their own merit. They move up and down on an individual stock basis. In bear markets if stocks are going down, usually all stocks are going down regardless of how the company is performing.
So you have two banks, one of which will eventually fail and the other which will emerge stronger because many competitors will disappear and they will survive. Who will win and who will lose between the two banks will be difficult to distinguish when things are bleak and investors who are panicky won't care. We will name them bank X (the one who fails) and bank Y (the one who survives). When things are deteriorating rapidly bank X and Y are both going to go down. When you have counter moves both will go up alot. Bank X may even go up more though it will ultimately fail. So say I am short Bank X because I correctly identified it is the inferior bank and have no position in Bank Y because it is to hard to tell if they will indeed make it (I have many such investments I could point to in this scenario currently). Well in the rallies especially, it is almost impossible to tell the difference. So if your trying to size positions and hedge and move out of hedges technical analysis can be a useful tool when dealing with probabilities of adding to shorts or taking profits and lowering exposure. Correlations become one. Bulls markets when things act more rationally and those who are succeeding are rewarded and those who are failing go down, the usefulness of the tool drops considerably (in my opinion anyway).
So with that backdrop in mind below are two graphs. Let me make it clear I have never read a book on technical analysis or done any sort of training. What I do is amateurish and really has developed from looking at stock graphs since the age of 12. My positions are made for fundamental reasons, the technical analysis comes in when managing size of my shorts on a portfolio basis and when to hedge and not hedge. Click on the graph below.
This first graph is the S&P 500 over the last 6 months. It includes the huge April May rally. What you see in the April May rally were two high probability tops that the market may have been done universally moving up. One in mid April and one in mid May (the actual top). They are classic type tops. Huge moves up early in the day after a couple of violent up days the days before (the final squeeze of the shorts and buying panic of those fearing getting left behind) followed by a slam down late in the day. The final buying barrage has been extinguished and it creates a decent probability that in a bear market that is the end of the bear market rally. We saw that a week ago Monday and I blogged that I thought it was a decent chance of that was it. Both tops in the April and May rally broke their trend lines. First break in April ended up being false (you are dealing with probabilities) as buy the dips still permeated Wall St while the second break was legit. We had another break after this last top. Very encouraging. I laid out my thesis a couple of days ago that while this rally was not as long at the Sep / Oct rally or the Apr / May rally that I thought probabilistically it was done. I also said it would be natural for the market to move back up to 1290ish. I was hoping the market wouldn't be that strong but it should be expected, that it would be a natural move. Below is the 1 month graph of the S&P. Click on it.
By looking at this graph you can see where I came up with this number. Today sure enough we went to about 1293 and couldn't break it. We have sold off below 1290 since.
If you are a bear we are not out of the woods. For one if you compare the six month and 1 month graph we did not break that 1260 area truly distinguishing a new low like we did in May. Also the reason I was so frustrated yesterday, which came out in a blog, is because once again in bear markets fundamentals in real time are not followed very closely which tests the patience in severe ways of fundamental investors. It is all about the reaction to the news not the news. I really had thought things had shifted. You had bad news on Wednesday which was shrugged off which while disappointing was understandable since the two days before the market had gotten slaughtered. Then though to see it followed up on Thursday with even worse news and the market shrug it off was very concerning. Then today the market is flying? Why? There is no real good news. The reaction if we had truly rolled over should have bee an open up 100 points and then sell off. Lehman is not news in my opinion. People keep asking me which bank I think is going to fail and Lehman keeps getting brought up and I keep saying no, it is going to get taken under. It doesn't really change the fundamentals at all.
So the market opened up and held the gains and then quotes from Bernanke in Wyoming crossed the wire and the market rallied some more. They were bad quotes. There was nothing positive I could see in them besides the fact that the Fed is stuck. That fundamentally things are getting worse and we don't know what to do about. Yet the market bought it. Bad news is still being bought which is very concerning.
What I am saying is that we have to hold this 1290 to 1300 area or I will probably be buying protection against my short book. It was a failed breakdown like mid April, the market probabilistically is heading higher, and it doesn't really matter if your fundamentally right, your shorts are probably also headed higher.
After saying all this I just want to emphasize that this stuff should only be used as a tool. I don't usually look at individual stocks this way. I don't usually look at going long a stock this way. My view in April and May were that it was a bear market rally. I hedged some in the beginning of the rally but took the pain as the market put together a very massive rally looking for a turn in the markets. Last time I got it right. I bought puts and greatly expanded my short exposure around 1400 on the S&P. I have done the same here but this may be a failed April breakdown. You have to know fundamentally why you are short or long something and then you can use this tool to help when to make a big swing. I could easily be wrong that a week ago Monday was the top. If I am right fundamentally though on my positions it won't matter in the long term. Where it matters is that I avoided the end of July and beginning of August shorting things even as the stocks increased until I saw a high probability opportunity with shorts I fundamentally liked. 1325 to 1340 is still the area where I think a rally almost has to come to a halt though I really don't want to have to wait though that.
No comments:
Post a Comment