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
12 May 2011 - CEO Herding Behavior - an update

 Back on 10th February 2011 we submitted an 'Observations' article on CEO herding behavior. It was in the context of the German Boerse bid for the NYSE-Euronext. Recent mega-sized buy out announcements have prompted us to update that article. Sentiment indicators reveal the extent to which investors follow the herd. Coming into May 2011 sentiment analysis revealed the most lop-sided bullish sentiment extreme since Market Vane began collecting sentiment data back in 1969. The timing of mega-sized buy-outs reveal that CEO's follow the herd as much as lowly investors.

27 Apr 2011 - The Federal Reserve and the US Dollar

Today's inaugural press conference by Ben Bernanke is being anticipated with almost as much hoopla as the impending royal wedding. So let us push aside spin and drill down for substance. Now is a good time to focus in on what the Federal Reserve is really all about. What do history and the markets reveal about the long-standing tactics of the Federal Reserve? And what have been the real real world impact of these tactics?

06 Mar 2011 - Crude Oil and the Magazine Cover Story Syndrome

 The barrel of crude oil on the cover of the current "Economist" magazine suggests that it is time to revisit what we have come to call 'the magazine cover story syndrome.' This syndrome refers to the fact that, by the time  a financial trend makes it to a cover story, that trend is likely already over or about to peak.

15 Feb 2011 - Geometry of 'Geo-Political' Risk

Over the past couple weeks many have asked me to comment on the upheaval in the Mid-East. This 'Observations' section exists so I can present a technician's view of the world that exists outside the realm of price charts. In this report I try to give a technical view of geo-political risk. That means finding key indicators, looking for patterns, and following the numbers.

Headwinds: Why QE2 Will Fail ( the slides )

'Quantitative Easing' ( QE ) is a desperate and extreme form of central bank intervention that has only ever been attempted under the conditions in which it is least likely to succeed. And in this regard QE2 is no exception. In this webcast we cover the formidable headwinds that QE2 is facing as well as the experience that Japan had with its many QE attempts. We also aim to clear up the many misconceptions regarding what exactly QE is and how it is supposed to work. There are two links here - this first link is to the webcast slides, and the second link below is to the webcast itself.

Headwinds: Why QE2 Will Fail ( the webcast )

This webcasts lasts for about one hour and twenty minutes. The slides that we employ in this webcast are available as a .pdf file to view and or print out from the link above.

16 Nov 2010 - Bubbles in Space

We live in the golden age of the speculative financial bubble. The art of modern day finance has been producing speculative bubbles at an unprecedented frequency. Art imitates nature. In one of the great ironies of our age of the bubble, science has just discovered what may well be the largest bubbles produced by nature. We can only hope that the mavens of finance do not attempt to outdo nature. We conclude with a review of key pivot prices for the major markets.

28 Oct 2010 - From Astronauts to Vampires: from bull to bear

This report builds on earlier observations concerning seasonal influences on stock market valuation and the relationship between bull markets and progress in the manned space flight program. The main focus of this report are observations concerning the relationship between bear markets and horror movies. The goal is to highlight collective consciousness as the fundamental fabric of the field of economics. Economics is such a dismal and ineffective science because the reality of a collective consciousness has been overlooked. We suggest that economics needs a metaphysics to make it worthwhile, relevant, and useful.

21 July 2010 - Falling Icons - follow up

Here we do a brief follow up on the report from 23 June 10

23 June 2010 - Falling Icons and Rising Anger

In this article I explore the case for an underlying trend as the single cause of a wide range of apparently disparate phenomena. Our analysis suggests that it is not just excesses in stocks and real estate that are being corrected by this bear market. The implication is that the excesses of American culture itself are now being corrected.

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