Technical Analysis Of The Stock Market

Includes: DIA, QQQ, SPY
by: The Joyful Investor

Astrology fascinated some of the most brilliant minds of the past. They included Galileo and Kepler. Today some lesser lights devote much effort and time to technical analysis of the Stock Market. In both cases, people are fascinated by the challenge of discovering meanings hidden in numerical sequences as observed in the sky or charts of the stock market. And they are lured by the promise of wealth and public recognition.

It must have come as something of a shock to readers of the Traders Column in the Investors Chronicle, that the trader, in his farewell article this week, should write,

"I have come to believe that much of what passes for Technical Analysis is nothing more than faith-based nonsense. It would be laughable, but for the real money that it helps to lose. I include in this several of the dark arts in which I myself have dabbled in the past, including Fibonacci, the Elliott Wave Principle, and much of Gann Theory."

It is rather as if Benedict XVI had announced that he was retiring from the Papacy because he no longer believed in God.

As readers of this blog might recall, one method of judging where we are in the stock market cycle is to review a list of down to earth indicators, such as those used by Howard Marks of Oaktree Capital Management. See here.

But I cannot resist presenting a chart prepared by (Doug Short) that I came across recently:

The chart tracks the flow of funds from individual investors in the New York Stock Exchange (NYSE). It is hardly a surprise that the S&P 500 rises on the back of inflows and recedes on the back of outflows. What is interesting is the magnitude of investor buying on margin since 1998 and the rapidity with which investors liquidated their positions in 2001 and 2008. American investors have become much more active with the result that markets are more volatile now than they were between 1945 and 1998.

Doug Short recognises that, as data for credit balances is available only six weeks after the event, it lacks any predictive power. But he comments ". . . the magnitude of the latest negative credit level is comparable to the maximum debt reached four months before the 2007 market peak. I see this as yet another caution light for investor expectations."

As the FTSE All Share Index closely follows the S&P 500, this observation is relevant for UK investors.