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Alex Trias
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  • Brief Overview of Technical Analysis
    Suppose you could find a statistical correlation to market declines, and the color of the President's tie. Suppose that 70% of the time, whenever the President wears a blue tie on Wednesday, the stock markets will take a 1% dive, on average. This Wednesday, before the market opens, the President comes out of the Oval Office wearing.... the dreaded blue tie. What do you do?

    One answer is that you chalk up the correlation to simple coincidence. Reason alone tells you that the color of the President's tie this morning cannot have any impact on stock prices, let alone force stock prices lower. In this case, you are substituting your judgement for what you actually see happening in the marketplace. Do so, and you are, in effect, arguing with the market.  One could say it is like standing on the tracks in the front of an oncoming train. You can either just stand there saying "but the train really isn't supposed to be here! It really SHOULD NOT hit me" or you can simply step off the tracks.

    Another option is to step off the tracks, as it were. True, it is silly to think that the color of the President's tie determines market prices, but there is no need to get into an argument about it when you can simply sell stocks and wait. The problem with this approach is that you might miss out on epic gains that day, at the risk of underperforming the market. If your goal is not to outperform the market, or even to perform at the market, but to simply preserve capital, the prospect of missed gains should not bother you.

    And what if, today, as the President stands there in his blue tie, and the markets not only DON'T sell off, but in fact, RALLY HARD? Well, the good news there is that you now see that selling stock on Wednesday whenever the President wears a blue tie does not, in fact, turn out to have been a great strategy. Since the strategy didn't work this time, you don't do it next time. You lost an opportunity, but you also avoided a 70% risk of taking a loss, and most important, you lived to fight another day.
     
    Technical analysis is, at the end of the hunt, nothing more than a blue tie worn by a President on a Wednesday. Simply because a "head and shoulders" pattern preceded a massive sell off last time, and several times before then, it obviously doesn't follow that it shall lead to a sell off this time. It only suggests that based on past history, this pattern tends to precede a sell off. You can argue that it is silly to ascribe any significance to the shape of a chart, or the color of a tie, or you can simply do what worked last time, and keep doing it until it stops working. Rest assure that other investors will do what worked last time, and that the pattern can become a self fulfilling prophecy. Also rest assured that still other investors will act well before the pattern is complete, potentially arbitraging the trading opportunity out of the system entirely. Still others will ignore the pattern entirely as being completely silly. You cannot know the outcome, but you can appreciate the risk, so whether you act on this risk really comes down to what your goals are. If your goal is profit maximization, then missing gains is of paramount concern and the less risk you take, the lower your gains will be. If your goal is loss minimization, exiting risk when you see it resting at it's riskiest levels is pretty much the name of the game.
    Jul 07 9:48 AM | Link | Comment!
  • Crash Brewing

    True to form, following confirmation of a bearish head and shoulders pattern, the markets are in the process of dropping hard and fast after a slightly positive opening. Past market history suggests selling pressure will continue, and given the light volume in the markets, and extraordinary levels of investor anxiety regarding losses and deteriorating macroeconomic data, it seems likely that this leg lower may ultimately end in panic.

    It is premature to do so, but investors who have already sold (such as the author) should consider their "re-entry" point. For example, assuming ten year average earnings of about 60 for the S&P 500, perhaps getting to a price level that sports a PE ratio of 10 or 11 might be a solid entry point? Alternatively, more technically minded traders may simply have to wait until the short term moving price averages vault above the long term moving price averages. That entails missing the bottom of the market, but preserves reasonable upside within the context of a longer-term upward trend. It also entails waiting for what could be months or even years prior to placing a trade.

    It may be unwise, however, to short the equities markets. Valuation of equities is somewhat high, but still reasonable. Volatility is so severe, a short position could produce devasting losses within seconds. Moreover, investor gloom is high, suggesting a potential for a contrarian move higher when nobody expects.

    Overall, I am maintaining a heavily overweighted cash position, low risk bonds, and nominal exposure to risky assets such as master limited partnerships, preferred shares, and junk bonds. Equities exposure remains below 5%, which to my mind represents the probality of the market shooting higher over the near term.

    Jul 01 10:33 AM | Link | Comment!
  • Head and Shoulders Confirmation

    That's it. We've resolved a head and shoulders market top pattern. The ride down should be choppy, but consistent. A near term price target for the Dow Jones should be in the 8,000 range, although if market disorder erupts, a flash crash or something like it could always drive the Dow far lower than that. 

     

    I am continuing to hold only 20% of the model portfolio in risky assets (mainly master limited partnerships and very light equity exposure) with 80% into treasuries and investment grade bonds and some cash. Hopefully, the treasuries and investment grade bonds will perform well during the coming bear market, offsetting losses on the risky side of the portfolio. I will review the portfolio once the Dow hits 8,000 or once the 50 day moving average for the global stock market reverses above the 200 dya moving average.

    Jun 30 5:11 PM | Link | Comment!
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