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Technical Analysis 101: Head & Shoulders Pattern

Recs

43

June 30, 2009 – Comments (62) | RELATED TICKERS: SPY

Although I know I'm going to take heat here from the naysayers of technical analysis, the Elliot Wave Theorists, and frankly anyone else here who doesnt like me, I'm calling the S&P firmly in the throws of a head and shoulder top.

A head and shoulders pattern is purely technical, as I've displayed below, whereby you have a move higher then lower (the left shoulder). This first move will set the relative value for your neckline (the level at which your moves lower will generally bounce). After this first move you get an even larger thrust higher which equally results in a move generally right on or very very close back down to the neckline; we call this the head. Finally, the last move higher is met by resistance at nearly the same level as the where the first shoulder stalled. What generally happens is the ultimate test of strength at the neckline. If the chart can hold within reason, say 2% of the neckline, the technical strength remains bullish. However, if the stock price falls decisively below the neckline on this final move, historical momentum has shown that the retracement value is generally the distance measured from the neckline to the average closing highs of the head.

Do I have figures to back this up? Well yes, but do I remember where the hell I read them, no =) From the last that I remember, head and shoulder patterns are the most accurate charting indicators. I believe that they correctly predicted the movement of a stock just a hair over 70% of the time. So more or less, a head and shoulder pattern on paper is accurately predicting a falling stock price 7 out of 10 times. (By the way, for all you perma-bears, keep in mind that reverse head and shoulder patterns exist so they are incredibly bullish).

More evidence needed? Well, from my holy grail of Technical Analysis, Edwards and McGee's "The Technical Analysis of Stock Trends" c.1964, the authors mention that head and shoulder patterns often see stronger volume on the first shoulder, then weakening volume on the head and even weaker volume on the final shoulder. If you look at the illustrated chart above, tell me if you notice a trend in the volume? Giving you goose bumps isnt it?

So what does this mean for the S&P? I think sometime this week we are going to run into some big problems between 928-933. If we break this mini-channel we're in ( about 913 or lower would do it ) we are almost assuredly going to re-test the neckline. These head and shoulder patterns tend to be fairly symmetrical in their nature but admittedly moves to the downside tend to be much more swift than moves to the upside. Downside pressure, taking into account the neckline at roughly 878 and the head at 954, should mathematically put us at 806 on the S&P within 5-6 weeks. I've been calling for 808 as my retracement level for about 5 weeks now and I'm going to stick with that level. Everything including my gut, the daily news and the charts points toward a retracement to 808 on the S&P.

Call me nuts... I know

UltraLong

 

 

62 Comments – Post Your Own

#1) On June 30, 2009 at 4:28 AM, GoodVibe4Ever (< 20) wrote:

I am one who will not call you nut! :) I agree with almost everything you said there except the gut and the daily news statement at the end. Actually I just posted this chart an hour ago before your blog Comment 31 here. So I guess we have something to agree about. Thanks for the detailed explanation and the chart and here's more.

GoodVibe

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#2) On June 30, 2009 at 9:36 AM, 01123581321 (87.22) wrote:

Excellent post.  I've been cultivating this setup for the last month, and now it seems like many Top Ranked Fools are in the same camp. 

In your earlier blog "18 Reasons We'll Pull Back From Current Levels" you mentioned: "I’ll never think of myself as a perma-bull or a perma-bear but I definitely think of myself as a skeptic 100% of the time."

I couldn't agree more.  While we are certainly due for a pullback and the chart appears to be setting up for one, I must ask.....can it really play out like so many think it will? 

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#3) On June 30, 2009 at 9:40 AM, mrindependent (72.99) wrote:

thanks for the "heads" up (eer I guess- down).

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#4) On June 30, 2009 at 10:40 AM, Vet67to82 (< 20) wrote:

Good post.  Great detail.   Get's a rec from me. 

   Interestingly, I find the mood in the market is one that is looking for any positive reason to move higher.  Mr. Maddoff "gets" 150 years ... and the market goes from red to green.  One "correction" that everyone is aware of but tends to ignore is the "sideways" trading range bound, correction over time.    

With the "worst" of the global meltdown behind us ... the next two to five years look to be a long slow slog back to 2008 levels.

 ... and it'll be different this time, 'cuz the meltdown, brought all the faults, flaws, and dregs to surface ... so when we get back to 2008 levels ... the "quality" will be substantially better.    

  

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#5) On June 30, 2009 at 10:56 AM, ralphmachio (25.70) wrote:

!!!!!    !!!!! 

Knowing very little about technical analysis, I was amazed yesterday when I was looking at the 2 and 3 month SPX chart.  really obvious head and shoulders set up.  Then I really got excited!  I checked the 10 year SPX, in the 'mountain' format.  Is it me, or are we in NOV, 2002?  If that's so, i would expect 725 - 735 within 6 months.  

the question is, what will happen then?  What propelled the market up in 2003 that we can imitate for 2010?  Some mystical form of alternative energy?  China?  What's the next bubble?  We've seen what happens when oil bubbles...

We suspect (some of us) manipulation of the market upwards.  What if that were to be reversed?

                                                                            !!!!!   !!!!!

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#6) On June 30, 2009 at 1:59 PM, trimobile (< 20) wrote:

elliot wave confirms H&S pattern... 

ralphmachio - history doesn't repeat itself but does rhyme. 

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#7) On June 30, 2009 at 3:32 PM, jesusfreakinco (28.98) wrote:

No one knows what / how the Fed will prop up this market.  Many of us have been amazed at how this market has been held up for the past few weeks.

Jeff

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#8) On June 30, 2009 at 4:08 PM, trimobile (< 20) wrote:

jeff - agree that it is tough to see how the fed is going to prop up the market with jobs being shed left and right.  it's pretty debatable whether the fed has nay power to prop market up or not with any lasting effect imo. 

 

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#9) On June 30, 2009 at 4:15 PM, jesusfreakinco (28.98) wrote:

Take a look at the video in the blog I just posted.  Interesting exchange on CNBC:

Wilbur Ross, Rick Santelli, Lary Levin - telling it like it is...

JFC

 

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#10) On June 30, 2009 at 7:56 PM, anchak (99.85) wrote:

Excellent analysis....most of us noticed this and were chatting about it in the GV lounge.

Also that paper by Tasty -does support your hypothesis about H&S being one of the simpler TA patterns which did stand the test of a Bootstrap ( that is a very hard one IMHO) - while failed the data snooping - which essentially says - although the TA rule is statistically significant - any chance of a trader picking it out of the myriads ( they tested 5000) of rules -would be by pure chance.....except of course generally good traders do over time figure out a way of knowing what works.

So this rule stands I think - probabilistically.

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#11) On June 30, 2009 at 7:58 PM, anchak (99.85) wrote:

Incidentally the reverse one is at 875-880 - where the fight is going to be .....it will not be an easy break ...

 

also this is like a 3rd retest - if it goes there this time - if it holds -  UL  - you are looking at some real nice Bear roasting by the bulls methinks!

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#12) On June 30, 2009 at 8:03 PM, TMFUltraLong (99.95) wrote:

Right, there has to be a decisive break of the neckline, and then usually a re-test of the neckline as a resistance point. If that holds and pulls back then its gangbusters to 808. I could just as easily see this being a headfake below 876 just long enough to trap the bears and attempt another rally above 915. I see this less likely, but I'm not ruling it out.

I'd have posted my head and shoulders thoughts earlier, but I wanted a chart to back it up. Not being very "computer inclined" I had nowhere to upload a chart to. I decided last night, what the hell, why not try flickr! So now I have a place to upload my graphs and charts to, so expect more of them! =)

UltraLong

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#13) On June 30, 2009 at 8:38 PM, anchak (99.85) wrote:

Thanks! and keep them coming

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#14) On July 01, 2009 at 10:27 AM, trimobile (< 20) wrote:

so far that right shoulder is looking very bulky

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#15) On July 01, 2009 at 5:31 PM, BEAR2008 (99.65) wrote:

Very good detailed advice UltraLong. The  period we are in is anything but normal. The market will not do as expected. Stay with the picks you have in Caps --- do not reverse them for the 100 point S&P down swing you believe will happen in the next 5 weeks or so to get more points in this game. Let it be and you will take the number one Fool spot soon! If you do go Ultra Bear for a few weeks don't stay to long and then get back on your Bull before November and ride this powerful new bull market for the next 2,3,4 or more years. I do not know day of the 1,000 point Dow rally that is coming but it will come! Best Regards, BEAR2008

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#16) On July 01, 2009 at 6:43 PM, halomaster (< 20) wrote:

hahaha...no offense, but you did expect this...you are nuts. There is no solid proof that there are trends in stock price or stock market movements. The stock market is not a jigsaw puzzle. Also to use probability theory on the stock market is foolish because the individual pps movements are independent of each other. Which means you can't discern what will happen in the future by relying on past data. You can't assume that past price movements are representative "sample data." No hard feelings...I hope.

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#17) On July 01, 2009 at 7:06 PM, portefeuille (99.60) wrote:

#16 halomaster, you might want to have a look at the books I mention here.

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#18) On July 02, 2009 at 2:17 PM, nicenos (55.51) wrote:

This is great coaching for us newbies.  The comments also add depth and great study materials for "un-techies".  I just know some stocks beat the S&P regardless of the market, or do better than..., so will study your input but still feel comfortable with my "watch and pounce" method.  Joined this "club" in March and thoroughly enjoy all the learning and exposure to some real experts...  A big thanks from a 68-year old grandma!

 

 

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#19) On July 02, 2009 at 9:16 PM, TMFUltraLong (99.95) wrote:

Ok, so we have confirmation that our head and shoulders pattern is in full swing. We've broken below the 50 day moving average, something not truly and decisively done since we started this massive rally. The down moves as I mentioned are swift as opposed to the gradual up days were saw during this rally.

If I had to throw a few predictions of future trading action out there (and these are mere guesses) I would say the following:

We move from todays close of 896 to c. 886 then bounce. This bounce should take us to c. 909 and will be the last gasp before our descent. The next move downward will be swift and will take us to c. 848. We will bounce briefly and in channel like fashion off of 848 back to c. 874 then stall again. We move from 874 in nearly straight and swift fashion again down to c. 814. We will bounce in channel like up fashion again to c. 835 then make our final descent to c. 808 where I feel we will put in another near-term bottom and will have mathematically completed the head and shoulders pattern. The time frame for this move I'd place at 4 weeks.

As I said, this is mere speculation using support and resistance, and from years of following technical trends. Does anyone really know, of course not, but its still fun to try =)

UltraLong

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#20) On July 03, 2009 at 1:13 PM, Mark910 (< 20) wrote:

Just curiouse why you haven't changed your CAPS picks if this is what you think is going on?

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#21) On July 06, 2009 at 10:17 AM, brocksamson (28.42) wrote:

Ah,

the self-reinforcing religion of technicals.

It doesn't matter if technicals are right 99% of the temporal time--they are massively wrong when it matters and and the real world does not abide by Gaussian statistics to make that even out.  It is not surprising that technicals show up as noise around the true market pattern given that lots of day-traders flush with cash believe this garbage.

However, we all know that those day traders are just kept around to make small profits on liquid positions.  When the big boys in the fund need cash for investments, the day traders and their religion get the axe first.

Whenever you see loose money policies, you're bound to see lots of "technical" noise by the day traders, as this helps masquerade the price increasing effects of firms purchasing large amounts equities (and vice-versa).

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#22) On July 06, 2009 at 9:43 PM, TMFUltraLong (99.95) wrote:

We move from todays close of 896 to c. 886 then bounce. This bounce should take us to c. 909 and will be the last gasp before our descent. The next move downward will be swift and will take us to c. 848. We will bounce briefly and in channel like fashion off of 848 back to c. 874 then stall again. We move from 874 in nearly straight and swift fashion again down to c. 814. We will bounce in channel like up fashion again to c. 835 then make our final descent to c. 808 where I feel we will put in another near-term bottom and will have mathematically completed the head and shoulders pattern. The time frame for this move I'd place at 4 weeks.

Wow, its a rare day in hell that I'm going to be right on, but 886.36 was the low and woo hoo, hoo haw and any other cheer I can think of. I'd like to see us teeter on the 909 mark for the next 2 days, then Thursday should begin our descent toward the neckline break.

UltraLong

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#23) On July 06, 2009 at 9:58 PM, camotop (21.56) wrote:

UltraLong - Nice call indeed.

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#24) On July 06, 2009 at 11:03 PM, booyahh (< 20) wrote:

"It doesn't matter if technicals are right 99% of the temporal time--they are massively wrong when it matters"

I would say buy and holders are massively wrong when it matters. Most technical analysts that I know jumped out of the market in 1999, and 2007. In both cases they avoided massive meltdowns  that burned buy and holders.

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#25) On July 07, 2009 at 11:15 AM, arboretum (28.34) wrote:

Looks like a case of "great minds think alike". Thanks for putting up the most detailed and persuasive case yet for the head and shoulders.

Anyone noticed any resemblance between this head and shoulders and the one that formed at exactly the same time of year in 1930? That one did a lot more than retrace the distance from the head to the neckline...

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#26) On July 07, 2009 at 11:37 AM, TheGreatSatan (99.99) wrote:

Technical analysts with their charts remind me of the ancient astronomers who named the constellations -- they see all kinds of "patterns" and fancy sh*t that isn't really there, when, in fact, the points of data are completely random.

TAs then argue post hoc that their "patterns" predicted the future.  When, at the time, similar and equally plausible reasoning could have predicted any number of differing outcomes.  Not to take anything away from the successful people on MF who engage in such practices, I'm sure some of them are very bright people.  But TA is mostly bs.  Re #24 above, I wouldn't label jumping out of the market in 99 and 07 as an application of TA, but rather just the exercise of common sense when stocks were very obviously overvalued based on fundamentals and other pieces of publicly available information (which is really fundamental, as opposed to technical, analysis).  The premise of TA is that you can predict market movement just from past performance (often just patterns on charts), rather than from engaging in a fundamental analysis.  Those who correctly predicted the crashed in 99 and 07 (other than those who did so by blind luck) very likely did so through application of FA, rather than TA (even if they thought that what they were doing was TA).

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#27) On July 07, 2009 at 1:22 PM, camotop (21.56) wrote:

TGS...not to get into a philosiphical debate here but there is pattern and design to everything in this universe. How can points of data be random in a causal universe? To say that data points are completely random is just jibberish.

 

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#28) On July 07, 2009 at 2:56 PM, TMFUltraLong (99.95) wrote:

TGS

It's not that technical data is "luck" so much as it is a relatively large group of traders big enough to influence the move in a stock based on a belief that random data points in the past can lead to their desired future results. Technical Analysis isnt the end all, do all answer to investing, but it can help to navigate exit and entry points based on patterns, supports and resistances as large groups of other investors are likely to see and use these same patterns when trading.

In your shoes think of it this way, "beware the power of stupid people in large groups" =)

UltraLong

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#29) On July 07, 2009 at 3:18 PM, TheGreatSatan (99.99) wrote:

Camo, we certainly could get into a number of deep philosophical debates (and get quite off-topic in so doing!).  Which is really why I so love following and studying the markets - it is such an intellectually challenging pursuit, and implicates so many different disciplines!

 My overarching point is that any "pattern" that exists in the markets is very likely already priced in at any given moment.  Consequently, except over the very long term, the markets' movements will be largely unpredictable, (i.e random).  But I do acknowledge that every once in a while prolongued instances of imperfection come may exist in the markets (e.g. the hight of the nasdaq in early '00).  Theories of human psychology attempt to explain why such stretches come about every once in a while (a good example of the markets as intersections of two or more completely different disciplines).

And I do belive that the universe, and life, is random (and, indeed, that life itself is an accident).  I believe that nothing is pre-ordained, and that no supernatural being(s) exist.  One question to think about -- at the moment of the big bang was it possible to predict that you and I would be sitting here at this very time having this very conversation?  But to get back on topic, by "points of data" I was referring to stars and short term market movements.  Obviously patterns do exist.  My point was that wrt markets, any "pattern" is very probably already priced in.  And re stars, I was comparing, w/ some hyperbole, technicians' tendency to see elaborate patterns in random movements to ancient astronomers' tendency to see elaborate patterns (e.g. scenes/characters from mythology) in what was essentially just a spread of random data.

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#30) On July 07, 2009 at 3:35 PM, MattH42004 (30.46) wrote:

I'll never understand why any post that mentions the slightest possibility of TA being used effectively receives such venom. I'm a proud resident of Graham-and-Doddsville, but I'll readily admit that there is a lot of self-fulfilling prophecy concerning technicals and short term market movements.

Regardless, this is another nice post UL. It looks like every facet of the recovery trade is unwinding right now. The money is coming back out of the risky assets (stocks, high yield bonds, commodities, the Euro, the Pound) and back into the safe havens (treasuries, the Dollar, the Yen). 

I guess 808 will depend on how many money managers who missed the move are ready to come diving back in with a correction. If the "animal spirits" are back you're probably right. Although I think I think the fundamentals call for a deeper drop.

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#31) On July 07, 2009 at 5:28 PM, RootnToot (30.06) wrote:

Rec 39 from me, thank you for placing your analysis and thoughts squarely in the line of fire!

And IMO, there is great order and harmony in the universe if we only take time to look. Great works and accomplishments most generally do not happen by accident. There is a certain order and method or process that is followed. Is a symphony just a collection of scribblings on some pieces of paper, or is there majesty and harmony in the way those scribblings are arranged and presented under the direction of its composer? In this harmony and this order is the grandeur of Creation.

A bit off topic I know, but the devil made me do it! ;-)

 

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#32) On July 07, 2009 at 6:21 PM, brocksamson (28.42) wrote:

#28 is a fair and accurate statement.

 

While I am a non-believer, this is my point on technicals.  I'm sure a person who had already decided to purchase an equity based upon fundamentals could in most instances find a slightly better price based upon the noise level of the technicals.

Many firms do just this--they plan their purchasing in a way to create a specific technical pattern and thereby achieve better prices (instead of the price shifting against them because of their bigness...).

The day-traders are basically convenient idiots.  They intentionally add noise to the market in a self-fulfilling way so that enormous firms can purchase stocks without moving the market drastically.  Since prices are signals and money is noise, we should expect this technical "resonance" effect at the moment.  They also have the added plus of making a small profit on liquid money.

The problem is that many equities have had at the heart of their price increase nothing but an inflated noise level masking as a signal.  This will be corrected (in real terms if not nominal)--many people who are following the technicals on certain ridiculously overpriced stocks will get burned.  When those days of reckoning occur, the losses for the TAs will be much more than their profits based upon trading the noise.

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#33) On July 07, 2009 at 9:26 PM, noescaper (25.30) wrote:

I don't think we should treat people using TA to trade the market as stupid as someone in the above allude to. Many people have successfully traded the markets using just TA without FA, though a combination of both TA+FA may enable them to harness even bigger success.

For those who keep saying that TA is useless and that support and resistance is non-sense, I doubt if they have done sufficient statistical research to try disprove the basic tenets of TA - the herd behavior.

If we try to statistically measure the level of fear and greed the general investing public have on losing/winning their money (assuming sustantial enough to make them feel stressful on losing or cheerful on winning), we as human should exhibit some level of tolerance beyond which most will make hard decision to cut loss on a position, or to become 'greedy' to buy into another.

However, TA may fail when sudden market events occur or when the fed/government exercise their influence to manipulate the market.

Also, I've learned from those who are very successful in the trading business that their long term investing/trading success is not based upon TA+FA alone, but more on their strong discipline of risk management.

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#34) On July 08, 2009 at 12:43 AM, halomaster (< 20) wrote:

The only pattern in the stock market is that good businesses go up in value and crappy ones go down. Anything else, like the head and shoulders pattern, is really just imagination.

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#35) On July 08, 2009 at 3:00 AM, noescaper (25.30) wrote:

Halomaster,

It sounds like you are a buy-and-hold type of value investor. We are talking about different timeframe to make money if so.

As far as most traders/investors go, the usual way to make money in the market is to buy low sell high, or sell high buy low . That's, to determine good entry and exit points based upon what the market is telling us...and TA can often better provide us with some (imperfect) guidance on the reasonably good price points based upon market sentiment, while FA (analysis for whether a company is in good / bad business) gives us more assurance on the longer term perspective. You can keep denying the merits of TA till the end of your life, but successful short-mid term traders have time and again proven it useful, and I personally have made money this way through a few thousand trades over the last few years.

However, you can still be correct in your own investment timeframe and make money your way. And I can also be correct to trade against you successfully on a different (assumably shorter) time frame.

For example, you have a "outperform" recommendation on IRBT on 5/8/09. Based upon my short-term (1-3 mths) TA perspective, it isn't a good entry point for a short term trade even though the company may be truly a good business to invest for the long term.

In fact, the IRBT chart pattern looks so bearish now that I am going to put in a "underperform" 1-3 months trade recommendation against it tomorrow. This is not a trade to personally go against your recommendation. It's just one out of the many trades I have based upon pure TA. You didn't indicate how long you would want to hold on to your position in IRBT, but that's okay. I'm only going to hold this "IRBT underperform" position for 1 - 3 months or shorter, targetting to exit it should IRBT decline to ~10.25, or to exit it with a small loss should it breaks above 14 (closed at 12.75 today). I may even decide to exit the position for a small win/loss if IRBT doesn't move below 12.50 but shows up with more bullish candles than bearish ones in its daily chart by end of next week, as I have no obsession in IRBT but to trade its short-term change of trend. I decided to open a bearish position in IRBT with a trading plan created based upon TA+risk management notions, ignoring FA because I don't intend to hold it for the long term; the same way I've opened many other positions. What's your trading/investing plan and timeframe on this position?

I may win/lose in this position, but it doesn't matter to me because I've many other positions and my overall game plan is to let winners run longer than losers over time. Though I am practically trading against you in this timeframe, this position may still turn out to be a winner for both of us (assuming I'll win)when you exit it on a different timeframe (I hope so).

My other point is - Your comments on TA aren't substantiated with any material evidence to prove your stance, and appear to be just your personal bias, ignorantly sentencing TA to dealth without giving it some fair justice/experiment. 

[Btw, one can also make money to trade side way or (narrow) range bound market through options...but that is beside my point.]

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#36) On July 08, 2009 at 3:46 AM, TMFUltraLong (99.95) wrote:

I have to admit today's straight downward trading came as a bit of a surprise to me, especially after we had rallied the prior day to close at a high. I am still going to stick with my assessment that we need one more gasp rally before breaking through 876. Perhaps we don't need 909, but 898-900 one last time would work which the S&P could easily do in a day.

As far as I can see and with what credence I can give to the technical data in front of me, 808 looks like an almost given. My fear here is we're in a very ugly, non-symmetrical head and shoulder bottoming pattern which could in effect take the S&P back to the 748-751 on panic selling. I find that possibility unlikely, but I'm not ruling it out either. As of now I remain bearish on the market.

UltraLong

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#37) On July 08, 2009 at 6:38 AM, Mark910 (< 20) wrote:

"As of now I remain bearish on the market."

Nope just checked ur cap picks and u r definitely not bearish

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#38) On July 08, 2009 at 9:48 AM, AllStarPortfolio (< 20) wrote:

Mark910 (97.94) , Ultralong is definitely bearish, but he is also very good at long term picks. His ability to pick long term, and then ride out the bear, does not mean he thinks he's riding a bull.

-solaris

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#39) On July 08, 2009 at 10:50 AM, AWF (< 20) wrote:

S & P Support Levels

Minor:= 841,729-- Utopia would be 841 holding

Major: 784,676 --IF 784 holds --Load -Up!

Defcon4:= 576---may you live in interesting times

Armaggedon=484

Everthing is beautifull in its own way.

All the Best

AWF

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#40) On July 08, 2009 at 12:16 PM, TheGreatSatan (99.99) wrote:

Re "Ultralong is definitely bearish"

-- I agree w/ Mark on this -- I don't see bearishness there.  But anybody w/ an "ultralong" time frame would likely not be bearish.

On a different note, Ultralong, I see that you have many green thumb calls on "double," "ultra," etc. etfs, and that you made many of such calls in early march, 09, close to the market's bottom (obviously an awesome call).  If you intend to hold these as long term caps "investments," I am curious your take re this article:

http://news.morningstar.com/articlenet/article.aspx?id=271892

And I've gotta say that I agree w/ Halomaster (34), and that I'm a bit surprised that we're in the distinct minority on this board.

I followed, and still follow, Halomaster's theory and became top fool (although I'm now down to an embarassingly low 22nd).  Green thumb good companies/securities, and red thumb bad ones.  That method seriously works.  Although I would add that I made the bulk of my points by red-thumbing bad ones (i.e. that are very likely to underperform), especially inverse leveraged etfs (literally guaranteed to underperform over time), airlines, auto-related cos., mortgage/finance related cos., companies on the brink of bankr., companies actually in bankr (seriously, who the f would ever buy stock in a company in bankr -- see the absolute priority rule in the bankr. code).

Next, re #33, ("I doubt if they have done sufficient statistical research to try disprove the basic tenets of TA - the herd behavior").  I certainly have done no such research, and, indeed, Lord knows I have niether the time nor the intellect.   And I suspect that most people on this board haven't done any either.  But such should not prevent them from reading about  sudies that have been done.  And on that note, in support of my posts above, I would just incorporate by reference Malkiel's Random Walk Down Wall Street, which (concincingly, I belive) describes studies that have been done re TA.

Finally, re #33's comment, "I don't think we should treat people using TA to trade the market as stupid as someone in the above allude to."  I don't know if he/she was referring to my posts, but I certainly don't belive that anybody on this board is stupid (and if I did (which i don't) I would never intentially state it in insulting fashion).  Indeed to the contrary -- to look at charts and see sh*t like very ugly non-symmetrical head and shoulder bottoming patterns, and to get into the kind of detail that TA's do, seems to me very complicated, and not for the stupid.  And if anybody can actually get that sh*t to work, then I certainly tip my cap to them.

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#41) On July 08, 2009 at 12:46 PM, halomaster (< 20) wrote:

Noescaper,

Let's look at the stock market from a purely mathematical viewpoint (for now). When you look at the individual pps share movements, the probability of either the next tick being up or down is 50%, regardless of what the previous pps movements have been. Anyone can sell at anytime they want and buy at anytime they want. This is proof that the stock market is really just a stream of random fluctuations and the data are independent of each other. There is no way to anticipate if the next tick is going to be up or down.

It is similar to flipping a coin many times. The probability of the coin landing heads or tails is 50% each time no matter how many times you do this. Now, over a large set of data (flipping the coin many times) a pattern will emerge, where the overall trend is around 50% heads and 50% tails.

Now let's step away from the math. I think you will agree that there is an overall trend in stock prices where good businesses go up in value and bad ones go down. Now, since it is impossible to predict what will happen with short term fluctuations, it is logical to play the overall trend of good businesses going up in value and bad ones going down. This requires FA and a large set of data, hence a long time period. Now what's a long time period? I'll answer that if your still there because this post is getting long. Also, I know this analogy wasn't perfect so don't go crazy over it.

Anyway, you mentioned TA as way of deciding when to get out and when to get in. As for me, the discounted cash flow method handles that. I don't hold stocks forever. FA and DCF estimates the value of businesses for me and hence let's me know when to buy and sell. With respect to IRBT, I'll be honest I'm not sure what the value of that business is. My outperform stems from the idea that robotics are the future. Also, most businesses go bankrupt from debt and they don't have any. Not to mention they have had a previous hit product, roomba. Now let me ask you this. What proof do you have, besides experience, that there are discernable patterns in the market's short term fluctuations? Anyway, I wish you luck with your picks.

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#42) On July 08, 2009 at 12:55 PM, portefeuille (99.60) wrote:

When you look at the individual pps share movements, the probability of either the next tick being up or down is 50%, regardless of what the previous pps movements have been.

No. Have a look at some of the books mentioned in this post.

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#43) On July 08, 2009 at 1:16 PM, halomaster (< 20) wrote:

Portefeuille,

Please elaborate, I don't have time to read those books. However, I have taken a probability and statistics engineering course. Maybe I should have said the probability of the next tick being up or down is around 50% because the size of the order can affect the pps movement. However, this can happen in either direction. Also this does not change the fact that people can buy or sell when they want. Hence, the data are independent of each other.

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#44) On July 09, 2009 at 2:13 AM, noescaper (25.30) wrote:

Halomaster,

I would associate TA much like fuzzy logic, instead of pure statistics or probability. It's pointless for me to debate over purist topics, however.

Since you didn't seem to have an interest (or time) to read a lot of books, there's no point for me to prove to you statistically or mathematically anything about the TA theory. I am not going to share my trade secrets for free anyway :-) And I am not going to tell you how I read the chart pattern of IRBT to arrive at my conclusion to trade it bearishly last night, which turns out to be a good bet today (down $1.25, or -9.8%, and thanks to you). Actually, it's not that difficult to see it after one reads >10 thousand charts over the years. It has more or less become an instinct for me nowadays, but it's really no point for me to elaborate to ones who don't believe in anything on TA.

Practically, I can write a book on this subject matter, given my Maths major years ago, but nowadays I am more interested to find time writing an automated trading program to trade the TA techniques that I found working for me. For those who claimed that TA doesn't work, I can only point out based upon my personal experience (>thousand trades) that not everything in TA works, and even for those which work, there're always some twists /adjustments to be made over time because certain parameters of the market conditions (for example, the rate/intensity of certain sentiments) change over time...

One can keep believing that the market movement behaves like tossing a coin, but for those who have access to Fidelity's WealthLab Pro software, it is an easy task for a techie to create a Monte Carlo simulation module using your 50-50% theory to back test such stock trading strategy of 'random walk' over the last 20 years, and I can almost guarrantee that one'll lose big deal over time if one trades the market this way.

Running such a simulation program will have to rely on historical data for its calculation, however. I know there will be many in here to proclaim that one can't use historical data points to 'predict' the future and will try to invalidate any proof using such data. 

I've no interest to debate on such religious assumptions. Go believe in what you want. All I know is I've practiced what I learned in TA and found how to make it work for me ~60-70% of the time, which isn't too great a winning accuracy, but is considered a good enough edge to trade the market successfully if risk management discipline is observed. You don't have to believe me, but based upon my trading results, I found myself have a much higher accuracy to trade the market successfully over the 1 week - 6 mths timeframe, than anything > 1/2 year because the longer it is, the more unpredictable events and major crosscurrents could occur. Arguably, one can claim that the longer the timeframe, the better the chance of letting time to correct any investing mistakes. However, given an ability to make less mistakes (thus less risk for me) on a short timeframe, long term trades are actually more risky for me. Which timeframe works better for oneself really depends upon what strengths (say TA vs FA) one have. For the untrained eyes (in TA), I do agree that the near term market movements appear like white noise (random) to them and they may have a higher success rate to trade/invest in the longer timeframe using FA.

I only partially agree with you on your statement that "there is an overall trend in stock prices where good businesses go up in value and bad ones go down" because there's a lack of a specific timeframe in the statement. It's probably a good statement for the very long term value investors, but it isn't good enough for me (and other sucessful short-mid term traders) to formulate profitable (short-mid term) trading strategies to ensure long term success in the trading business.

Don't get me wrong. FA is a great tool. I only frown at  your negativity towards TA because I found that using FA alone can be very risky - how often the stock price of good businesses tank for no fault on their own (say when the overall market tank)? Using FA without TA is like one tries to brave the waves of irrationality of the herd based upon only a strong belief that the undercurrent will turn the tides at the end. Well, it will one day, but how long it takes? And can one financially withstand the waves for so long? Why not to ride the wave up and down happily just like wind surfing and adopt an always cautious attitude to protect oneself (by risk management discipline) in case the waves go against us?

Having said that, I know that many financial planners/advisors out there keep telling their clients that nobody can predict the short term markets and it is a sure-loss way to invest/trade. Sad to say, they are just propagating a belief without seeing themselves how the successful (not the failed ones) short term traders trade. They may have done a great service for those who have no interest to learn more about better trading/investing themselves, but they are doing the rest a disservice as far as I can tell. While nobody can predict precisely every market movement, the market often give many hints for some major impending movements, and you don't need to be 100% accurate to trade successfully (fuzzy logic!). 60-70% is good enough.

They want you to believe that nobody can time the market because their personal (and their firm's) bottomline relies upon your believing in them for doing a better job than you learning how to trade short-mid term yourself.

 

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#45) On July 09, 2009 at 2:38 AM, TMFUltraLong (99.95) wrote:

Let the battle begin!

Admittedly I've been rather annoyed that we havent had any strength here over the last 2 days, especially after that mini rally we got on Monday. We did however have a channel we we're in as illustrated above which I had not paid credence to before. We should bounce tomorrow based on those Alcoa numbers which were just good enough not to be putrid and all the green shoot artists can come out of the woodwork and move us higher.

What you will likely see is that last gasp effort higher now as I would bet money plenty of bears got trapped short under 875 today on the break of the neckline. One particular intricacy of those necklines is they need to be broken decisively and closed below. Trading 3-4 points below them intraday just isn't good enough if you ask me.

Ironically if you extrapolate the channel out a few more days, it seems pretty likely that the S&P 500 could rally as high as 908-909 (which is what I thought it'd go to anyways) before puttering out for good, and by that I mean killing the intermediate rally we've been in.

I am in no way preaching new lows here or Alstry-like damnation, but we've been overdue a nice, healthy correction and I think we'll get it.

UltraLong

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#46) On July 09, 2009 at 2:56 AM, portefeuille (99.60) wrote:

... and don't forget the 200 day moving averages.


enlarge

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#47) On July 09, 2009 at 3:14 AM, TMFUltraLong (99.95) wrote:

Portefeuille -

If there's one thing I can't stand, its moving averages. I take them into consideration only because of the "herd theory" mentality that other traders will consider them when buying and selling. In my utopia world, MA's don't exist. Ironically the 50 day is going to coincide nicely with my upper channel limit. But I still dislike MA's...

UltraLong

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#48) On July 09, 2009 at 3:31 AM, portefeuille (99.60) wrote:

I guess there is no point in paraphrasing it, so here is a comment from a different blog.

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#8) On July 09, 2009 at 3:26 AM, portefeuille (99.97) wrote:
I agree to some extent (the longer the time frame the more I agree, I guess).
The thing that lets me wait (I might add to my gold/silver positions when the price of gold drops to around 700 USD/oz) is what Redeker and Hendry and quite a few others have recently said. Everybody loves it, just like Goethe said, but right now they don't just love it, they go crazy ...
Maybe it really is not the best time to buy when your cab driver and the media tell you to do so.
I have the same feeling about this "head and shoulders formation" in the chart of the major U.S. stock indices. I should ask my next cab driver about it!

--------------------- 

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#49) On July 09, 2009 at 3:38 AM, portefeuille (99.60) wrote:

I don't like them too much either (the moving averages) and I guess for the same reasons as you.

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#12) On June 23, 2009 at 9:06 AM, portefeuille (99.97) wrote:
Figure 2 of the document shows what I thought when I first heard of moving averages. They lag by construction. If you shift them back ("centered MA") they smooth things out. If you do not shift them back they show "momentum". There is probably not much more to it. There importance comes from "go with the flow (momentum)" and the self-fulfilling prophecy aspect.

--------------------- 

(from here)

They did inspire me to start some "real research" though (1 -> 2 -> 3 (!)), so I guess I should be thankful ...

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#50) On July 09, 2009 at 3:45 AM, portefeuille (99.60) wrote:

What is somewhat ironic is that you actually need those cab drivers (or chartists) to sell once they are told (or tell) that the head and shoulders thing is important. But too many of them "trapped short under 875 today on the break of the neckline" could also be the foundation for the next rally ("upwards").

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#51) On July 09, 2009 at 3:53 AM, portefeuille (99.60) wrote:

There importance

Their importance 

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#52) On July 09, 2009 at 3:54 AM, TMFUltraLong (99.95) wrote:

About half of those trapped bears will exit their positions at a loss over the next 2 days as the market rallies back to 900, partially inflating the so-so earnings news I figure we'll be getting from a few major companies. The other half will wisely hold onto their shorts or perhaps add in a few days.

UltraLong

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#53) On July 09, 2009 at 3:57 AM, portefeuille (99.60) wrote:

I am sorry, it was early morning here in Germany. Your charts feature the moving averages so there was really no need for me to paste a separate chart. It does add the "exponential" version ...

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#54) On July 09, 2009 at 4:03 AM, portefeuille (99.60) wrote:

Once we are at 900 in 2 days I might reiterate my observation that maybe it is just boring (i.e. indifferent sideways "action") since the beginning of May (hehe).

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#55) On July 09, 2009 at 4:07 AM, portefeuille (99.60) wrote:

(just checked whether I am still one of your "favourite" players (i am.). i feel that I do not really deserve that status but then again i might just be one of your favourite contra-indicators!)

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#56) On July 09, 2009 at 4:10 AM, TMFUltraLong (99.95) wrote:

Your mathematical and blog-linking abilities are unsurpassed, you'll remain my favorite. And no need to apologize, its only 1am in Seattle, still early over here too =)

UltraLong

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#57) On July 13, 2009 at 9:00 AM, portefeuille (99.60) wrote:












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#58) On July 13, 2009 at 9:02 AM, portefeuille (99.60) wrote:

(nothing special, but a very distinguished presentation ...)

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#59) On July 13, 2009 at 9:19 AM, Dividends4ever (< 20) wrote:


i agree with the article.Caution is needed right now.Then long term thinking to plan for the future. www.compdivplan.com 

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#60) On July 13, 2009 at 11:24 PM, TMFUltraLong (99.95) wrote:

This is amazing. It's like im reading a play thats halfway over, yet i have the script and can turn 20 pages ahead to see if im right. I am absolutely terrified at how textbook the market is trading right now. Your parents always tell you that if its too good to be true, it must be, but this market setup is undeniable.

The 50 day moving average is currently 911, the downsloping channel factoring in tomorrow's trading moves to 914.50 (give or take a half point), and given the pennant-like patterns we saw on the rise from 666, we will probably see a dome like death (for lack of a better word) after what I expect will be a solid rally tomorrow. Overall If I saw this market trend to 905-910 tomorrow, and then stick within 905-916 between Wed-Fri before rolling over I wouldn't be shocked. We are mere days from what I suspect will be a major breakdown of all S&P 500 supports. I will be taking positions in SPY puts over the next few days.

Finally, to quote Ren and Stimpy,

"Happy happy joy joy, happy happy joy joy"

UltraLong

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#61) On July 14, 2009 at 8:04 AM, portefeuille (99.60) wrote:

... boring (i.e. indifferent sideways "action") since the beginning of May ...

I was talking about that (horizontal) no-trend channel.

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#62) On July 14, 2009 at 11:30 PM, TMFUltraLong (99.95) wrote:

Another day of perfect action... I would expect Intel's beat to open us up around 912.80-914 with us trading up to as high as 916 within the first 45 minutes. The rest of the day should be a slow death with us ending the day around 907-908. The setup looks perfect.

UltraLong

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