OPENING POSITION
June 2001
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Looking for an edge? You're not alone. Data mining is big these days as investors and traders scour the market for tendencies such as how often a large move on Wednesday is followed by a similar large move the following Tuesday - or a retracement. What's the "tell" on a surprise adjustment of the federal funds rate, an inadvertent indication of some sort that shows what's going on? What's the return from selling the first close above a round number and buying the close below the round number?
Do markets have tendencies that can be spotted and exploited, like quarterbacks and safeties? Can the tendencies be played to enhance your odds?
Definitely. We've run articles in STOCKS & COMMODITIES many times over on this very subject. It doesn't take much experience to realize that most market action is overly reactive, bending to the pressure of millions of individual circumstances. If there's a lesson to be learned from the growing body of evidence describing the behavioral traits of investors, it's that they are far from logical. Plus, investors are generally busy, greedy, and lazy. If they were all diligent, there would be far less work for professional investors who, presumably, are logical and discerning of true value.
However, like all market tells, signals need confirmation by the one thing that counts: price action. I was taught this by Walter Bressert, who developed the original version of Cycle Trader (currently shepherded by D.H. Financial, now merging with Linn Group). Having trouble getting "good" signals to work, he learned to add one rule: price had to move in the correct direction above (or below) the previous period's levels. Extending that to every system wouldn't be a bad idea; at least, it's worked for me.
It's fine to get a signal from a technical device, but it's better to have price confirm it. At worst, you're in a good position to stop out if the breakout doesn't follow through. At best, you've made a good entry and your expectations are unfolding properly.
Still, if the ultimate signal is price action, what does that say about what we should be following? I think it's price action itself: higher highs/higher lows, lower highs/lower lows. The basics of price behavior should lead us at nearly all times, and in all time frames. Indeed, the point of viewing price data compiled into a chart is to see what the tendency of prices is: move higher, move lower, or stay unchanged? It's only later we add lines and boxes, and indicators and commentary and who knows what else. The raw chart should be firmly in our minds - not photographically, but empathetically; that is, we have caught the message of past behavior. We've internalized the message of its changes. We "understand" the stock, to borrow a fundamentalist phrase.
This internalization is the true tell. It should carry you through the blizzard of other information. It's the opinion of thousands of other participants, expressed in their actions. It's not only what they did but what they are likely to do next. We haven't captured that in a quantitative manner - yet; but it's out there.
- Good Fortune!
John Sweeney, Technical Editor
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