Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Month: October 2011

Gold Weekly Buy Signal

Gold finished last week bullish and gave a buy signal in the weekly chart.

I call this signal “Buy The Dip” and it gives us a good buying point. But no buying signal is ever good without a proper exit strategy. But if you are being long-term bullish on gold like I am, you should widen that stop loss. So please remember to always define your exit signal before you take on a trade or investment.

A wider stop loss means you also need to take a smaller position on your trade. But I hope most readers already have gold in their long-term portfolio as insurance as I have written about before.

The last local low point was $1,535 so that will be my stop loss unless sentiment changes.

[Edit: Added the following paragraph on Nov 1st]

Mark Hulbert who is tracking sentiment in his Financial Digest wrote on the 25th of October that “[…] gold market exposure among the short-term gold market timers […] dropped to its lowest level in two and one-half years — minus 13%.” This will really help to give the positive signal above a kick-start.

gold buy signal chart buy the dip

NASDAQ 2% Below Ten Year High

Just an interesting note: NASDAQ 100 is only 2% below its ten-year high now. How many years ago was it that we reached the 10 year high last time? Actually it was this summer. I guess that, intuitively, this is not what most people would guess.

nasdaq qqq 10 year high

A Quick Look at the Stock Market

A quick look at a chart of the stock market movement since the October bottom. Annotations provided in the chart. Feel free to leave a comment!

stock market  contrarian rally

The Common Denominator why both Left and Right-wing Activists Occupy Wall Street

The Common Denominator which brings both Left and Right-wing Activists to Occupy Wall Street.

left right politics libertarian socialism occupy wall street

… too much government. Which ironically boils down to be only a socialistic problem. So come on socialists, think again.

As an added bonus also check out this next cartoon:

government bailout banks

Symmetry in Compensation – Occupy Wall Street

Nassim Talab claims that the reason for the demonstrations on Wall Street is about asymmetry in compensation. Thus to fix this problem we need symmetry in compensation.

Symmetry in compensation basically means that the upside for bankers on Wall Street, the rewards, should equal the risk for losses. What we have seen so far is that bankers have made million dollar bonuses, and they still are, but when screwing up they get bailed out by the tax payers.

Here is the video by, Nassim Taleb, one of the most important persons of the century:

Cartoon for the Weekend

riots at wall street iphone

The Truth Behind Technical Analysis

Let us take a look at technical analysis, which is used by many to make a profit by predicting the stock market.

Technical analysis is a set of tools used to analyze the movement or behavior of a stock or index instead of the facts surrounding the company or the economy, which is usually used when trying to predict where stocks are heading.

trend channel technical analysis

Trend Channels

Some use trend lines or channels to figure out the trend, some use resistance and support lines to see where there will be a lot of buyers or sellers.

One of the problems with this approach is that in any given chart, even randomly produced, you will in hindsight easy spot a trend. Of course if a chart is randomly produced you will not be able to forecast the next move. So how come you can do that in the stock market?

People in the field of statistical analysis are often dogmatically blindfolded. They might claim that since so many people are using it, it cannot be wrong. Or they know successful people who are using it, or even use it successfully themselves.

technical analysis support resistanceHowever, this type of reasoning suffers from strong statistical bias, such as survival bias, where only the winners tell the story about how good it works. While the losers go back to their jobs and usually do not speak so much about their failure. It could also be that since some only use a long strategy only, in a rising market. In other words they would have done well be just buying and holding.

Scientific research

Now let us look at the scientific research in this field. Oh yes, there is quit a bit of research, but strangely enough it never reaches the believers.

In the research paper “On the Analogy Between Scientific Study of Technical Analysis and Ethnopharmacology” via CXO Advisory they write:

There are four areas of similarity between folk medicine and technical analysis:

  • Both have foundations in folk science, with most claims proving false when subjected to rigorous scientific testing;
  • Both have strong potentials for statistical bias, the placebo effect for folk medicine and data snooping for technical analysis;
  • Both boast commercial popularities that support large markets for products/services; and,
  • Both are possible sources of scientific knowledge (for pharmacology and financial economics, respectively).

The essential lessons from folk medicine for testing of technical analysis are:

  • The study of technical analysis should mirror the rigor of drug evaluation methodology (e.g., randomized, double-blind, placebo-controlled trials involving homogeneous populations);
  • The study of technical analysis should include greater emphasis on explaining the behavioral mechanisms underlying hypothesized market inefficiencies; and,
  • There should be a independent peer-reviewed journal devoted to the rigorous testing of technical analysis.

In another scientific peer-reviewed paper, “Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals” via CXO Advisory it says:

David Aronson opens with two contentions: (1) “much of the wisdom comprising the popular version of TA does not qualify as legitimate knowledge;” and, (2) “TA must evolve into a rigorous observational science if it is to deliver on its claims and remain relevant.”

None of the 6,402 rules tested on the S&P 500 index, after adjusting for data mining bias, generate statistically significant outperformance. More complex/nuanced rules, or other financial data sets, might indicate abnormal returns.

From the paper “Identifying Noise Traders: The Head-And-Shoulders Pattern in U.S. Equities”, where a commonly used technical pattern called “Head and Shoulder” the following is summed up by CXO Advisory:

The author determines that head-and-shoulders pattern trading exists but is on average unprofitable, mistakenly interpreting randomness as information.

Is technical analysis worthless?

Yes and no. It is if you do not have a quantifiable edge. That means that you must have a statistical edge before you trade or invest. A rigorous back-test of your hypothesis must be done. What most people seem to do is that they are guessing or using some false authorities providing them false information about what is supposed to give them an edge.

Not even if you are back-testing your strategies to gain a statistical edge you are guaranteed future winnings. In fact there will be long periods, minutes, hours, days, or a lifetime where a historically proven winning strategy will become a losing one. To avoid this, look over your strategies often and see if they are obsolete in the current environment, and use many different strategies to diminish the risk.

The human brain is not particularly well wired for finance and trading. That is the reason why not even central bankers or countries know how to run their economies.

Most of the argument on technical analysis above can also be applied to fundamental analysis such as P/E-ratios, the FED-model, dividends-yield, et cetera, but that is for another article.

I would say that probably more than 90% of the “knowledge” out there on trading and investing is bogus, so watch out. Maybe even this article is, so always use your most critical judgment, and if you cannot, staying out of the markets will win you do most in the long-run.

Good luck! (or rather stay out of the luck part and in to the field of competence instead)

Market Wizards Lecture

Jack Schwager, the author av the trading bible Market Wizards, now has a lecture that can be watched on Youtube or here below.

Since most of his advice is very good, you can really understand that he is a smart man who interviewed and learned from some of the best traders of all times.

The whole lecture is divided in four pieces.

Part 1

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Part 2

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Part 3

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Part 4

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Related Article:
Quotes from Market Wizards

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