I've often heard some investor-traders refer to technical analysis as "voodoo." Granted, there's a lot of so-called "indicators" out there that are more than a little mysterious and subjective, from Gann lines to planetary alignments. And some of their proponents are in their own galaxies as well.
But analysis of charts, whether you call it "technical" or otherwise, has some other credible windows on the "fair" price of assets and commodities that you may not readily think of at first. One is psychological -- in fact, I often call technical analysis "psychological" analysis because of my passionate interest in behavioral economics -- and the other is statistical.
I look at charts for important support and resistance levels, like swing highs/lows, and confluence between different time frames. I also look for areas of consolidation or congestion that precede a trend continuation or reversal. And I look at the simplest of indicators for trend, moving averages.
Now, even many of my option trader buddies who do volatility arbitrage are TA cynics. But, what I have to remind them of is that looking at volatility charts is a form of "technical analysis" just like looking at moving averages of price. They are both based on historical statistics, plotted on a graph in a given time frame. They hate when I tell them that, because they think that statistical vol arb is somehow more pure than "voodoo" statistical price analysis.
Here's an update on what some longer-term "statistical" analysis is showing in recent FX action:
The 200-week simple moving average for spot EUR/USD is around 1.3365 this week. Last week, we closed just above it and this week we barely even said "hello" to it--okay, we kissed it--before taking off to the moon. Yes, fundamentals drove the explosive rally as investors exited an over-done, safe-haven bid in a currency that was printing debt geometrically. But, a big force too was the billions in "technically-driven" FX funds that were watching the euro build a base around $1.25 and the models that liked the acceleration above the 200-week enough to start piling in again once the run-away train got a good head of steam.
As I always say "price precedes fundamentals." This is a point you can argue about all day, but not with me. I don't think it's worth arguing about because what I really mean, and what's really important here, is that the fundamentals are often too complex, too deep, and too subject-to-interpretation and weighting for even 3 among a dozen professional economists to agree on, let alone for little-old-me to see clearly.
So I loosely watch the fundamentals (GDP and inflation forecasts, trade and policy measures, etc.) and try to figure out a view, while all the time religiously watching (you like that?) what the market is actually doing. What you usually find is that the price moves significantly, and then all the "correct" hindsight economists come out of the woodwork to tell you why this is this and that is that.
For sure, there were some super-smart economists and analysts whose fundamental analysis was spot on, early on. They knew to sell the euro at $1.60 in the middle of last year. But I didn't know to sell it until it crashed through $1.53 and $1.50, key areas of support that once broken indicated a sea-change of sentiment. And for sure, they and many of their super-smart cohorts at super-big money center banks like Deutsche, Citi, Chase, UBS, and even Goldman knew to buy the euro at $1.25.
But I didn't know to buy it until it broke-out above $1.30, tested $1.2550, and then took out several swing highs above $1.30 all in the space of two weeks. I'm just not as smart as the big bank players who analyze much more fundamental data and spend tremendous hours mining it because they manage tremendous amounts of money based on it.
Okay, back to the long-term moving averages... The other beautiful trade this week happened this morning when, as the euro vaulted to 12-week highs in a 4-day, 13-cent move, the posted high was hairs between both the 50-week moving average (around $1.4725) and the 200-day around $1.4710. Yesterday's high was $1.4718. Sure you could have taken profit or shorted the euro at $1.44 Wednesday after such a huge 10-cent run in only 3 days. Or, you may have taken my cue to watch the resistance between $1.39 and $1.40, which was real until the FED carpet-bombed the world with more dollars then they really needed. See my piece "FED All-In Bomb Blows Up the Dollar."
And many traders probably did take-profit or short at $1.44 (or $1.39, gulp!), and that's what drove the rally further, as everybody had to get out--or felt they had to "get back in!" But you can't argue with those moving averages giving some smart players a guide to the blow-off top in an unstoppable momentum move. I talked to one of them on the floor of the CME who, instead of hitting some bids in Euro FX futures, bought some very affordable puts on those futures and cashed in when it tumbled back to $1.42.
Technical analysis is, simply put, the short-term way to make money off of human behavior's longest-term trait -- irrationality. The fear and greed, the hope and regret -- they are written all over the charts. You only have to know how to look with the simplest of tools, not the brains of an economist.
Tomorrow I'll tell you what to watch for to see if the euro bottom is solidly in and 2009 sees the 200-week average continue to climb at the behest of a lot more $1.40 handles than $1.30 ones.