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WZ's Observations

Technical analysis is not another way of doing fundamental analysis. It is not another way of getting the same information. A fundamental analyst studies the various physical supply and demand factors in order to gain insight into the physical pressures that drive price trends. Technical analysis gives insight into the forces of human nature that drive price trends in the markets.


For a fundamental analyst, bullish fundamentals should only drive prices higher, and bearish fundamentals should only drive prices lower. A technical analyst recognizes the primacy of human nature and the role that emotions play in the markets. A technician has recognized that a bull market is not simply capable of ignoring bearish fundamentals and bearish news, a powerful bull market will turn bearish fundamentals into bullish factors and rally accordingly.  And similarly, a bear market will ignore bullish news. In fact, a technician can confirm the direction of the price trend in the market based on what type of ‘news’ the market is ignoring. What determines which type of news the market will ignore - bullish or bearish? The determining factor is the collective mood of the market.


A bullish collective mood will drive a price trend way beyond levels justified by the ‘fundamentals.’  And a bearish collective mood will drive prices way below levels predicted by the fundamentals. The dynamic here is not the rational analysis of individual investors buying based on new information. The dynamic consists of investors buying because they see others buying. Price discovery is herding behavior, the fundamentals are secondary, and the collective mood is primary.


There is a limit to the degree that herding behavior can drive prices. Prices in an up trend will eventually top out and reverse lower, and prices in a down trend will eventually bottom out and reverse higher. However, careful analysis of price trend reversals reveal that trends do not reverse because the fundamentals change. For example, a bull market will never peak and reverse lower because of a surprise bearish news story. A bull market will only peak on an even more bullish piece of news that fails to maintain the up trend, and a bear market will only bottom once an even more bearish story fails to drive prices lower.

This sudden loss of trend can be quantified through a momentum divergence indicator like the RSI or a sentiment divergence indicator like “Market Vane.” This loss of trending power can be confirmed visually in the shape of a candlestick reversal pattern. And the price at which the peak or trough occurs can be predicted through a system of chart pattern analysis like the Elliott wave system. These are the various tools of technical analysis.

Observing Human Nature
There is yet another approach to technical market analysis that derives only indirectly from price chart patterns. This other approach derives from the fact that the collective mood of the market creates both the price trend and the nature and content of the news. This other approach is a close study of specific incidents that reveal herding behavior creating the nature and content of the news.


What one looks for in this regard are logical disconnects. For example, something that should be bearish is widely touted as justifying higher prices. For those caught up in the emotional content of the trend no disconnect is perceived. “It is all good.”  But for someone with a modicum of objectivity, not every news story makes a great deal of sense. Incidents where a bearish development is especially celebrated as bullish - such disconnects are especially prevalent in the final stages of an up trend. And stories of ‘babies getting thrown out with the bath water’ are most common in the final stages of a down trend.


This approach to market analysis is frequently a magnet to intense criticism. First of all, the most egregious examples of the collective mood manufacturing “news” occur when the collective mood of the market is at its most intense - intensely bullish into peaking action and intensely bearish into bottoming action. Suggesting that a major bull market is about to end will never make one popular. In a bullish mania pointing out the logical inconsistencies in a bullish news story will invite allegations of a bearish bias. One will be accused of cherry picking the news to fit one's bearish views. One may even be consigned to the category of ‘those who missed the up trend and so are full of sour grapes’.


It is nevertheless fascinating to see how fluid the truth of the news can be under the pressure of a herding behavior driven collective mood. When we spot a particularly dramatic example of this process by which the collective mood creates news, we will report on it in this section.  Our goalis not be to clever or controversial. Our goal is to contribute insight into how markets move, how up trends peak, and how down trends bottom. Our goal is to give insights into the world as seen through the eyes of technical analysis. And the usual tools of technical analysis can help us identify those periods in time where such insights are likely to be most readily available.
WZ's Observations

 
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An Apple Sell Signal ? 02 Feb 10

We began covering the Nasdaq back in August 2000. Back then it was an excellent 'canary in the coal mine' for the impending collapse of the global stock markets. Apple stock is arguably a canary's canary. We think there is much to be learned from this stock - especially right now.
On Capitalism, the Fed, and Bernanke

Those held accountable for major screw-ups will say extraordinary things in an effort to get off the hook. The past couple weeks have seen two dramatic instances of this phenomena.
Immediate Openings: Scapegoats Wanted: 09 Dec 09

 The dynamics of human nature on the scale of the collective consciousness generates a self-sustaining cycle of alternating periods of increasing positivity ( bull markets ) and increasing negativity ( bear markets ). These cycles permeate all aspects of human endeavor.
Zombies and the Financial Markets: 13 Oct 09

 In this essay we will be looking at the timing of the release of ‘Zombie’ movies for clues to the nature of the collective mood that helped launch the movie in the first place and then helped make it successful.
Ancient Myths and Modern Markets: 30 Sep 09

 As is the case in all myths we take the gods to represent the deeper forces of human nature. What at first appears to be stories of the gods interfering in human affairs is actually an insight into the power of the deeper forces of human nature itself. Myths give insight into the dynamics that drive human nature.
Cheerleading and the Soundness of the Banking System: 06 Oct 09

 It is only natural to be patriotic and think of ones own country as indispensable and irreplaceable. This is cheer leading. It is natural, but it can also be quite dangerous.  If the cheerleaders in the United States can be believed the US banking system has been repaired. This rating from the WEF suggests that we should be very skeptical of the claims of these cheerleaders, and manage our investments accordingly.
Technical Facts versus Emotional Hopes: 18 Sep 09

 The structure of the decline from the all time highs in the various stock markets ( each and every major, international stock index ) is unmistakable. It is a five wave decline. And as we have repeatedly emphasized there is no such thing as a five wave bull market correction....
Speculative Bubbles

The period since 1995 has been rather a ‘Golden Age’ of mass delusions and their speculative bubbles.  There are simply not enough “What Were They Thinking Awards” to go around. The initial mass delusion in this period was the near unanimous certainty that the easiest path to riches was to be long as many “dot-com” stocks as possible......
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