* This article should not be construed as offering financial or trading advice. It is an opinion piece which uses real time data to illustrate a philosophy.
Over the years I have developed a respect for technical analysis (charts) and a great disdain for the talking heads on TV.
There are two main schools when it comes to analyzing the stock market. First, there's fundamental analysis where a stock's price is calculated based on Earnings Per Share and other factors. This is a very consistent and accurate method when it comes to determining a ballpark value for individual stocks. Technical analysis is a method of predicting a stock's movements based on the chart of its past performance.
As a rule of thumb, fundamental analysis drives technical analysis. Over the course of decades, the market can reliably be expected to yield approximately 5% annual growth, as justified by the fundamentals. You could almost look at a chart and predict that the market will continue this growth into the next decade and beyond.
But many people confuse the multi-year picture with the daily one, and treat the market as a whole like they would an individual stock. The problem here is that the market is not rational - it doesn't always go up on "good" news or down on "bad" news (I used scare quotes to show that good and bad are a matter of opinion). You can not always justify its price with fundamental analysis.
It was just a matter of time before this current market receded from the newly minted highs (DOW 15,500). The technical pressures are enormous. Now that it's happening, the pundits are all scrambling to explain it with recent news. But the news doesn't matter.
The conventional wisdom says that news events move the market. Funny, though, when the news breaks, the pundits cover themselves by saying "there's no way to know how the market will react to this." No, they wait to see how things will shake out, and then they boldly try to explain it all. The market does what the market is going to do, and as much as the pundits like to apply hindsight to their explanations, they are merely retrofitting the narrative onto the facts. In my opinion, it's all bullshit.
The intense navel gazing among pundits reminds me of the fallacy, Post Hoc, Ergo Propter Hoc (after this, therefore because of this).
[There's more below the divider-doodle]
On a day-to-day basis, just about half of all the market's movements are DOWN. The annual growth rate is what concerns the long range traders, but the real action is in the intraday fluctuations. Someone who is bullish on the markets may actually be fading the current rally, and this is a healthy view to take.
So, when the market goes up, people obviously make money. And when the market goes down, there are also a lot of people who still make money. And both sides of this equation rely on new money pouring into the market. New money is required in order to hit new highs, and the new money allows profit taking to occur without crashing the market.
I'm very cynical. I don't see how the pundits at CNBC or anywhere else can be so naive as to not take advantage of market pullbacks. They may seem to be bullish all of the time, but that's just a ruse to keep the new money pouring in. CNBC can't afford to tell their viewers the truth about market fluctuations, because then their audience would participate in the same trades their friends are trying to make. The pundits are pumping the rally so that the insiders can fade that rally.
Oh, sure, I know. That would be illegal and unethical and I'm sure they don't actually engage in that behavior. /sarc
Before I go on, I must give you all a short lesson in Point & Figure (P&F) charting. This is a way of drawing a stock chart which compresses time along the horizontal axis. It is drawn on graph paper - you remember the kind with a grid of boxes - and it is filled in on a column-by-column basis. Each box represents a fixed number of points, so a chart with a 5 point box will be more detailed than one with a 25 point box, while the 25 point box chart will have less "noise" as seen in small fluctuations.
A column of X's indicate that the stock price has been going up, and a column of O's shows that the price has been going down. As the stock moves, you continue to fill in the current column of either X's or O's until the direction reverses, then you begin a new column. Therefore, columns always alternate between X and O. Since a column continues as long as the current market trend does, it's not unheard of to see a column that goes on for more than a year (e.g. 2004-2007).
Wherever there's a number in a box, it shows the month in which that box was filled in (A, B, and C representing October, November and December) and the years are marked sporadically along the horizontal axis.
Here is a P&F chart of the Dow Jones Industrial Average with a 250 point box
If you look back to 2007 you'll see that was the previous all-time high for the Dow. When the market pushed through 13,750 in February of this year it created a new high and at that point I predicted that it would continue until at least 14,500. It is very unusual for a chart to rip into new territory and exceed the 45 degree trendline without pulling back to consolidate at the point where it broke out. Therefore I think the market will return to 13,800 for at least a short while before proceeding on to new highs. I made that prediction on March 10, and it's still as valid as it was back then.
Now, not to toot my own horn, but I'd like to illustrate how effective "big picture" trading can be. Here's my track record, as archived by Twitter:
Feb 17, 2012 "I smell a shakeout on the horizon" (DOW 13,000)I'm sure that during this time many a pundit has offered their own theories, but in none of these predictions do I try to explain the why or the when of the market movements, because it's pointless, just a bunch of hot air.
May 6, 2012 "Predicting the DOW will lose 8%, but long term wants to break resistance set in July '07
May 19, 2012 "CNBC discussing short strategies - I'm almost ready to call a bottom"
May 21, 2012 "I'm looking for 12,200"
June 3, 2012 "DOW in reversal territory here"
June 13, 2012 "Agree with Cramer's hyper-bullish S&P predictions, translates to 14,500 for DOW"
March 10, 2013 "Retrace to 13,800"
And the approximate percentage changes that my predictions yielded:
Feb - June, 2012 --- 13k to 12k = 7.6%
June 2012 to June 2013 --- 12k to 14,500 = 20.8%
16 month total gains = 28.4% and that's not counting the headroom, i.e. we hit 15,500 on my bull cycle but I'm only counting to 14,500, since if I were trading I would have begun to take up short positions at that point, shorting all the way to the top. Nor do my estimated gains include straddle positions (E.g. May 25, 2012 - "One strategy here would be to accumulate stock and buy puts to protect against 12,000")
In summation, the markets are bracing for a pullback, and when that happens don't let them blame it on Obama, the PPACA, or refusal to approve the KXL. Que sera, sera.