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
02 Aug 2012 - Wave Count of a Faceplant - Facebook support

Our first 'Observations' report on Facebook was released on 26 May 2012. That report viewed the Facebook IPO debale through the window of behavioral economics. This report employes Elliott wave analysis and Fibonacci ratio analysis in an attempt to locate potential long term support.  

27 June 2012 - The '4-4-2' Euro-zone Solution

Our suggested "4 - 4 - 2" solution to the Euro-zone crisis is not nearly as creative as the Greek adaptation employed for tax collection. Our idea goes back to the soccer pitch notion of separating the players by skill set. In this brief article we suggest that the Euro-zone should break up into three sub-zones. Instead of continuing to fight the cultural divides that make one big Euro-zone unworkable, we suggest using the cultural divides to create more perfect unions, plural.

20 June 2012 - Thank God for Greece?

For an optimist the collapse of the Greek stock market makes all the other markets look positively buoyant. However this relative buoyancy is a mirage. Take Greece out of the picture and all the other stock markets find themselves in the same sinking ship. From the field of behavioral finance we know how powerful the "self deception effect" can be. We have seen how the "wishful thinking effect" and the "optimism bias" can blind one to the risks ahead. The risk from here is that Greece is not an exceptional worst case. The risk from here is that Greece is the market leader. In this brief report we compare the stock market price action of Greece to ten other major stock markets and the CRB Index.

14 June 2012 - The SPX is an Inverse VIX

The VIX was supposed to track the implied volatility of S&P 500 Index options. The VIX was supposed to estimate expectations of volatility, not trend direction. Yet since 2007 the facts reveal a different story. The actual price action shows that the VIX has become a fear index. The relationship between the VIX and the SPX shows that this is not a risk on, risk off market. This relationship shows that the more accurate description is a fear on, fear off market.

26 May 2012 - The Facebook IPO

The week leading into the Facebook IPO on Friday 18th May was a week that saw an increasing intensity of mass euphoria. The ebullience of Friday morning the 18th had turned to confusion by the close of Monday 21st May. By Tuesday’s close the confusion has turned into wrath. This report is about understanding how the collective mood could undergo such a dramatic reversal from ebullience to wrath. This report is about how the most eagerly awaited IPO in many years so quickly soured to a financial Hindenberg scale disaster. “Oh the humanity!”

13 March 2012 - Sarkozy and the CAC 40: Shared Fates

13 March 2012   For a President the tone of the collective mood makes the difference between re-election and removal. A bull market is a rising tide of hope and optimism in the collective consciousness. The rising mood lifts stock market valuations and Presidential approval ratings at the same time, and with equal ease. The next Presidential election will be held in France, and Sarkozy is up for re-election. In this report we employ technical analysis to look at his prospects.

17 Oct 2011 - Webcast - Deflation Update: USA and Europe

October 17, 2011: The special hour long webcast covers two situations. The first subject are the deflationary forces impacting the USA consumer. The second half drills down into the nature and origin of the deflationary debt crisis in Europe. I put this webcast together because I have yet to see any news service or analysis present an accurate picture of what is really going on.

Webcast Slides

October 17, 2011: These are the slides that I presented for the 17 October webcast. The first section deals with the delationary forces acting on the USA consumer. The second section drills down into origins and significance of the deflationary European debt crisis.

08 Sep 2011 - Dear OECD, so is it finally 1984?

I do not have a big problem if a small stock broker uses the incredibly stupid term "negative growth" to try and pry a buy order out of a hesitant client. Stock brokers are people too and have bills to pay. And I do not have a big problem if a small company uses the absurdly ridiculous term "negative growth" to try and reassure shareholders that things may not be as bad as they look. However I have a huge problem when an organization of some of the largest economic powers in the world uses the ludicrous term "negative growth."

03 Aug 2011 - Horror Movies and Bear Markets: a sequel

In an 'Observations' report dated 28 October 2010 and entitled "From Astronauts to Vampres: from bull to bear" we detailed the causal link between bear markets and horror movies. This is a sequel to that report. Here we look at the implications for the stock market of the fact that a major, genuine horror movie will be released this Friday. It promises to be the most chilling of all the 'planet of the apes' films. And with respect to the profitability of this film the timing of its release could not be better. Hollywood looks once again poised to profit from a rise in collective fear.

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