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 goal is 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
29 Nov 2012 - Economics is Human Nature

At the birth of economics as a field of study the central role of human nature was widely recognized. After all, Adam Smith’s two books were ‘The Wealth of Nations’ and ‘The Theory of Moral Sentiments.’ But then the pseudo-scientists of neoclassical economics staged a coup and tried to reduced everything to the mechanistic formulas of mathematical equations. Evidently many economists were jealous of physics. The false notion of an efficient market was just one of many disastrous consequences of this approach. But lately the tide seems to be turning back to an appreciation of the central role that human nature plays in the field of collective human behavior that is the very fabric of economics. The latest evidence for this sea change is from an interview with Rogoff and Reinhart  in this week’s Barron’s.

15 Nov 2012 - Fibonacci Big Winner in 2012 Elections

In our tutorial “Fibonacci Aspects of Consensus” we note that whenever a group of non-experts are asked their opinion the result is invariably a 61% to 38% split in the poll. One almost never sees the 50 – 50 split result that common sense might expect. In this one page bulletin we cite two important  61% - 38% splits in the recent presidential election.

13 Nov 2012 - A Report Card for QE3

Today QE3 is two months old. Happy Birthday? Not really. The market impact of QE3 so far is not at all what most expected. The day after QE3 was announced, 14th September, the major stock indices and commodities peaked and the US Dollar bottomed. Was not the reverse supposed to occur? We noted this on 14th September and in a couple weekly reports since. Here we look at this phenomena in more detail. The wider implication is that Bernanke is not winning his war against deflation.

05 Nov 2012 - Technical Analysis, Politics, and Government

In a nutshell this report looks at both presidential political campaigns and the success or failure of governments through the window of technical analysis. After all, that is the purpose of these ‘Observations’ reports. How does the world look from the perspective of technical analysis? In this report we take a brief look at the world of politics and government.

18 Oct 2012 - Myth of Energy Independence - the webcast

Energy independence is an issue again, and just in time for the election. In this webcast we aim to separate the myths of energy independence from the realities. Will increased domestic supply lower our energy bill? If not, then why are we in such a rush to deplete our domestic reserves? Are our fears of energy dependence being seized on by special interest groups? If our concern is the price of energy then perhaps we should be looking to the Federal Reserve instead of OPEC. The bottom line is that policy based on myths always ends up contributing to the problem. It is never a solution. The first step toward a real energy solution is to strip away the myths.

18 Oct 2012 - Myth of Energy Independence - the slides

These are the slides that I worked from in the webcast. They are in PDF file format 

15 Oct 2012 - Nobel Peace Prize to the EU ?

Given the economic and social upheaval in Europe, the violent protests against EU policies, and the sharp aversion that Norway has demonstrated against joining the EU, the granting of a Nobel Peace prize to the EU is further proof that we live in the golden age or irony. What was the Nobel committee thinking? Is this award a sympathy card or merely an ill-timed congratulations?

27 Sept 2012 - QE QE 1, 2, 3

QE3 is being sold to us as an attempt to lower unemployment levels through the Fed buying agency Mortgage Backed Securities. However it is a different pitch for the same game - create massive amounts of new money, dump it in the laps of the major money center banks, and hope the economy recovers. In this report we look at the stock market, the CRB Index, and unemployment levels from a QE perspective.  

12 Sept 2012 - Is the Fed a Religion?

The massive weight of collective hope that was formerly invested in Facebook has moved on. That hope and faith is now focused squarely on Ben Bernanke and the Federal Reserve. The mania has been transplanted, however it is still a mania. Never before in history has so much faith been invested in the Federal Reserve. And that brings us to the topic of this observations report. What happens if Ben disappoints? And even if he does not disappoint, the risk is a massive buy the rumor, sell the news reaction.

11 Aug 12 - Summer Olympics and the Dow Jones Industrial Avg.

This report explores the price action in the Dow Jones Industrial Average ( DJIA ) in the context of the Summer Olympics. The Summer Olympics occur in the epi-center of the May to October seasonal bearish phase of stock market price trends. Given that stock market trends are driven by the collective mood of the market, and all else being equal, we would expect a bear market rally in stocks from the opening ceremony to the closing ceremony of the Summer Olympics. This report reviews the DJIA price action over the last ten Summer Olympics.

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