Posts Tagged ‘technical analysis’

Explosive gold price movement ahead. But up or down?

Tuesday, September 1st, 2009

In Marc Faber latest market commentary report, he highlighted the fact that gold prices had been range-bound since February this year. But as the months progresses, the price range gets narrower and narrower:

Gold prices trading range

In technical analysis, this type of price formation is called a “pennant.”. A pennant is like a spring coiled up, ready to jump at any moment. As the price range narrows, it can be interpreted to mean that buyers and sellers are getting more and more polarised and entrenched in their convictions regarding the next move for gold prices.

This means to price volatility for gold will be upon us soon. The question is, which way? Up or down? Marc Faber opined,

I lean toward the view that gold will break out on the upside. The only problem I have, however, is to reconcile my relatively positive view about the price of gold (and other precious metals) with a rebound in the US dollar and a correction in equities. Of course what could happen is first a rebound in the US dollar and a brief correction in gold and equity prices before these short term trends – driven by further monetary easing – reverse, and gold (as well as other commodities) and stocks move up again in tandem.

However, our view is that should the precious metal prices fall (in the context of correction in equity prices and rebound in the USD), the fall may be quite substantial (we could be wrong here). This is because others traders and speculators are also watching the pennant formation in gold prices and should the break-out prove to be on the downside, they’ll be likely to press the “sell” trigger.

Another possibility is that in the coming correction, gold prices and USD may go in the same upward direction. That happened before last year as US Treasuries and gold were rising simultaneously (in the context of capital flight towards safe havens after the collapse of Lehman Brothers).

Ladies and gentleman, what are your bets? Up or down? For options traders, they can bet on both by buying in-the-money call and put options.

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Posted in Gold, Looking Forward | 18 Comments »

Bear market rally on the works?

Monday, October 13th, 2008

Back in What is the meaning of ?oversold?? Part 1: Technical analysis perspective, we explained that

In technical analysis, there is a class of indicators called the ?momentum indicators.? Examples of this indicator include stochastic, Relative Strength Index (RSI) and so on. Basically, these indicators measure the momentum of price movements. If the momentum is far too much on the upside, then it can be said that the prices are ?overbought.? Conversely, if the momentum is far too much on the downside, then they are ?oversold.?

The theory behind momentum indicators is that at the either extremes (i.e. oversold or overbought), it is a matter of time before exhaustion sets in and cause prices to reverse. In that sense, these indicators are contrarian in nature because it tells the technical analyst to sell when prices are overbought and buy when they are oversold.

One month has passed and the selling momentum had intensified and brought prices even lower. Many technical analysis indicators have now approached extreme bearish levels.

At such extreme levels, it is very possible that we will see a counter-trend rally soon. But please note two things:

  1. It does not mean that prices cannot go down further in the short-term. Who knows, perhaps there will be more panic selling in the days to come, thus bringing the technical indicators into even more extreme levels?
  2. In all likelihood, such a counter-trend rally will still exist in the context of a bear market.

In the infamous Great Depression bear market from 1929 to 1932, stock prices did not fall straight down. As we explained in Second lesson of ?29 crash?bear rebound,

Back in 1929, the bear market rally lasted for around 6 months from November 1929 before resuming a downward trend.

You may want to take a look at the stock charts from 1929 to 1933:

29to32percentchart
Source: Financial Armageddon

Notice that many of the bear market rallies last more than a month, the longest being 6 months.

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Posted in Looking Forward | 11 Comments »

What is the meaning of “oversold?” Part 1: Technical analysis perspective

Sunday, September 14th, 2008

In our previous article, Are some Aussie resource stocks oversold?, we said that

Thus, if you look at some of the massive falls in some of the smaller resource stocks, it looks that they are being oversold.

Thanks to the comment of one of our reader, Pete, we realise that there are a lot of subtleties and meaning packed in this simple word “oversold.” As such, depending on your perspective of this word, misunderstandings can arise. Therefore, we will give this word a fuller treatment.

For today, we will approach this word from the perspective of technical analysis. In technical analysis, there is a class of indicators called the “momentum indicators.” Examples of this indicator include stochastic, Relative Strength Index (RSI) and so on. Basically, these indicators measure the momentum of price movements. If the momentum is far too much on the upside, then it can be said that the prices are “overbought.” Conversely, if the momentum is far too much on the downside, then they are “oversold.”

The theory behind momentum indicators is that at the either extremes (i.e. oversold or overbought), it is a matter of time before exhaustion sets in and cause prices to reverse. In that sense, these indicators are contrarian in nature because it tells the technical analyst to sell when prices are overbought and buy when they are oversold.

So, when we apply this concept to the Australian dollar, gold, commodity and resource stock prices, many of their momentum indicators indicate that their prices are ‘oversold.’ Therefore, in the days to come, it will not be surprising to see that their prices will stage a counter-trend rally as traders who utilise technical analysis starts buying.

In the next article, we will explain the perspective of “oversold” from the value-investing perspective. It will be a long one.

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Posted in Investor Education | No Comments »

Revealed: Stock market dirty tricks?manipulated sell

Tuesday, February 27th, 2007

The stock market is a wild place where fools are often parted from their money. It is also a place where fortunes are accumulated by the wise. Besides the fool and the wise, the stock market is also a place where gamblers, speculators and punters play with their luck. It is also an ideal place for the sly to practice their bag of dirty tricks. Today, we will look at one of their dirty tricks.

Back in Crowding at the exits, we mentioned that:

One popular idea among technical analysis is the concept of a ?support level,? whereby stock prices are expected to ?rest? on and rebound from. Traders often place their ?stop-losses? on the support level, which is the price level that they will sell their stocks in order to cut their losses. As the stock price rests on some traders? stop-loss levels, it triggered their stop-loss sales of their stocks. Such sales put downward pressure on the stock price, which may result in other stop-loss levels to be breached, which in turn triggered even more stop-loss sales. The outcome is a very steep and rapid fall in stocks prices.

Such widespread use of technical analysis can present an opportunity for the well-resourced foxes. Stock prices often fluctuate within a range. The lower bound of the range is called the ?support? level and the upper bound is called the ?resistance? level. Traders using technical analysis may see any breakthrough out of these two levels as significant because such an event signals a change from the status quo. Thus, they may place their stop-loss price (the predefined price in which existing holdings of the stock will be liquidated if the stock price fall to it) below the support level.

What would these foxes do when the stock price approach the support level? As you may have guessed by now, they would sell the stock (either from their existing holdings or borrowed) in order to push down its price to below the support level. This in turn will instigate a wave of selling. The outcome is a very rapid drop in stock price that the foxes can then exploit for their benefit.

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Posted in Investor Education, Market Observations, Technical Analysis | No Comments »

Is trend following trading risky?

Tuesday, January 30th, 2007

In a nutshell, Trend Following is a trading strategy that buys (or technically speaking, go ?long?) when prices are in an uptrend and short sell (or technically speaking, go ?short?) when prices are in a downtrend. Unlike other trading and investing strategies, trend following only look at one thing for its buy or sell decisions: price. Also, trend following does not try to anticipate price movements or foresee long-term fundamental outlook?it merely reacts to price behaviour.

Does trend following works? Michael Covel, in his book, Trend Following?How Great Traders Make Millions in Up or Down Markets made a thorough case for this trading strategy. We suggest you read his book if you are interested in the idea of trend following.

However, there are some in the finance industry who claim that trend following is very ?risky.? The underlying reason for such a claim is based in the fact that trend following exhibits very volatile returns. Is there any flaw behind such a claim?

First, how is volatility measured? Standard deviation is most often used for measuring volatility. The calculation of standard deviation requires the statistical mean as one of its input. Here lies the weakness for the claim that trend following is ?risky??the underlying assumption behind standard deviation is that prices follow a normal distribution As we said before in How the folks in the finance industry got the idea of ?risk? wrong!, this assumption is generally not true in practice. Price often moves in trends, and the incidence of extreme movements (e.g. 1987 stock market crash) shows that normal distribution is an invalid assumption. Therefore, according to the assumption of normal distribution, meltdowns like 1929 and 1987 are so rare that they occur once every billions of years (we are not sure of whether it is billions or millions, but you get the idea). Thus, if you believe in trend following, you cannot believe in the idea that volatility that is defined by standard deviation is ?risk.?

One more thing: since most of the financial industry uses the faulty normal distribution example as the basis for measuring ?risk,? we cannot help but feel that perhaps much of the financial risks in the world are being wrongly appraised. If that is the case, the next fat-tail event will indeed draw many nasty surprises.

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Posted in Investor Education, Trend Following | No Comments »

Crowding at the exits

Sunday, January 7th, 2007

Recently, we had done anecdotal verbal surveys and observations among the people we know. We notice these curious trends:

  1. More and more people (i.e. retail private investors) are trading the stock markets on the side. Leveraged derivatives, like Contract-For-Difference (CFD) are increasingly being used.
  2. More and more people believe that a big crash will happen one day.

For the first trend, that may explain the increase in volatility among the stock market, which in our opinion often does not exhibit the most rational of all behaviour. We believe one of the reasons is because of the widespread use of technical analysis. One popular idea among technical analysis is the concept of a ?support level,? whereby stock prices are expected to ?rest? on and rebound from. Traders often place their ?stop-losses? on the support level, which is the price level that they will sell their stocks in order to cut their losses. As the stock price rests on some traders? stop-loss levels, it triggered their stop-loss sales of their stocks. Such sales put downward pressure on the stock price, which may result in other stop-loss levels to be breached, which in turn triggered even more stop-loss sales. The outcome is a very steep and rapid fall in stocks prices. This outcome is an example of irrational and volatile market behaviour that is increasing in frequency. With easy availability of (1) leveraged instruments like CFDs, (2) instantaneous communications via the Internet and (3) automation of trading via computers at the hands of the common people (who are not trained to think like true investors), this effect becomes magnified even more.

For the second trend, it may be the consequence of the fact that the common people are beginning to understand and see the absurdities, excesses and greed in the financial systems. Unfortunately, even among those who believe that a crash is inevitable, they still have a substantial portion of the wealth in the stock market, either voluntarily through their side trading, or involuntarily through their superannuation. For some of these side traders, they may believe that it is all right as long as you know ?when? to get out of the stock market.

This is the scary part.

If you sincerely believe that a crash is inevitable, you have to understand these facts:

  1. You cannot know ?when? to get out. Crashes always take the majority by surprise. Otherwise, the majority would have gotten out long ago, which means it cannot be called a crash in the first place.
  2. By the time you know it is time to get out, chances are, everyone else does too.

What is the implication? The first trend, along with these facts implies that when a crash happens, it will be so extremely rapid that vast amount of paper wealth will vanish in seconds as the gigantic herd heads for the crowded exits simultaneously. Your chances of surviving a crash with your wealth intact is pretty much zero. Even scarier, since the vast majority of people have much of their accumulated wealth in the stock market through their superannuation, a crash will affect this vast majority, which is an unprecedented scale in all of human history.

Please bear in mind that we are not predicting a massive crash in the days ahead. We are highlighting the important point that if you sincerely believe that a crash is inevitable, the time to get out is NOW, which is the most rational thing to do. The ideas of (1) an inevitable crash and (2) staying in the stock market while the party is still on, are mutually incompatible. On the other hand, if this is not your belief, then you can pretty much ignore everything this article has to say.


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Posted in Investor Education | No Comments »

Telstra?s share price vulnerable in the short-term

Saturday, December 16th, 2006

For those who bought Telstra T3, they made a giddy gain of 34% in one month. This gain in one month, through the extrapolation of 34% to the next eleven months, is equivalent to 6003.49% of return (compounded monthly) per annum! Of course, in reality, you will not get this kind of return for almost all of the stock market investments available in the universe. Perhaps you may find such a super stock, but we guess your chances of doing so are pretty much zero. On the other hand, if you are a very capable (or lucky) businessperson, you may achieve such a return through your own private business. But anyway, let us now all stop dreaming and get back to earth.

Today, for a change, we will delve into some technical analysis. Some analysts may scoff at technical analysis and place it in the same league as astrology. But for us, we prefer to be agnostic about it. The reason being, since there are so many traders in the market employing the use of technical analysis, it will become a self-fulfilling prophecy.

Looking at the chart for Telstra?s share price we saw that it rosed from a low point of $3.59 in 21st November to yesterday?s high point of $4.12. We guess those who sold Telstra shares at that low point must be kicking themselves now. Right now, Telstra?s share price is in a strong uptrend and has increased in volatility. However, our technical indicators are telling us that its momentum has already approached the overbought level. Therefore, it will be vulnerable to any less than favourable news in the short-term. At this point in time, short-term traders are most probably positioning their fingers at the sell trigger and will pull it at the first hint of a pullback in Telstra?s share price. Since the price of Telstra T3 instalment receipts tracks the price of Telstra shares, it will also follow suit in that event. Please note that we are not predicting the short-term fall of Telstra?s share price. For all you know, the upward momentum may continue. But in that event, it will even be more vulnerable to any short-term pullback.

However, for the long-term, our views on Telstra remained unchanged (see Is the Telstra T3 offering worth a buy?).

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Posted in Analysis - Stocks, Looking Forward, Telstra | No Comments »

How much should we listen to the financial media?

Thursday, November 16th, 2006

Let’s take a look at this media report in The Australian (released in the afternoon):

THE stock market was down at noon as concerns about a slowing US economy kept local resource stocks at bay despite a recovery in commodity prices overnight.

Now, look at this media report in MarketWatch (released in the morning after the overnight market close in the US):

U.S. stocks rose Wednesday with the Dow Jones Industrial Average stretching to a fresh record close after surprising strength in a regional survey eased economic worries, with further help from Altria Group Inc. and Boeing Co. and news of a possible merger in the airline sector.

So, the question is, is the US economy going to be all right or is it heading for recession? The US market and the Aussie market seem to think differently. But which market?s thinking is right?

We believe that to be a successful investor, one has to filter out noise in the financial media. You have to understand that the market is the herd and the herd possess herd mentality. If you ask a member of the herd the reason why it is behaving the way it is, you will probably not get an answer based on clear logical reasoning?basically it is behaving that way because other members of the herd are doing the same. The financial media, in order to sell their stories, have to come up with specific ?reasons? for every of the herd?s behaviour even though at times, there may not be one.

The next question: who leads the herd to behave that way?

In the market, there is one group of participants who are called the traders. They have an influence in the day-to-day movement and volatility in the market. Many of these traders use technical analysis as a tool in their trading decision. The basic premise of technical analysis is that market price movements exhibit repeatable patterns, which are used to gauge the probability of future price movements. What do you think will happen if enough market participants use technical analysis? Well, the result is herd behaviour in which technical analysis becomes a self-fulfilling prophecy! So, when you hear words like “technical selling” in the financial media, you know what it means.

Thus, always read the financial media with a pinch of salt.

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Posted in Market Observations | No Comments »