SMSF Investment StrategiesSharing Simple Strategies for Self Managed Super Funds

Subscribe via email

Grab our RSS Feed

My favourite information sources – Part 4

I have covered a number of my favourite sources of fundamental information in the first three posts in this series so today I would like to cover sources of “non-fundamental” information which include technical and sentiment analysis. Technical analysis involves looking at price charts, technical indicators like volume, moving averages, Fibonacci retracement levels, and Moving Average Convergence / Divergence (MACD). Recently, a few interesting technical patterns have showed up on the charts and you may have read about the “Death Cross” pattern observed on the SPX 500 chart in early July 2010 or about the “Head and Shoulders” pattern that appears to be forming on the chart of this widely followed index.

Technical analysis is not very popular in Australia and I know many stock investors do not even look at charts and rely purely on the fundamentals. The chart patterns discussed above for the S&P 500 can also be observed on the price chart of the major Australian stock indexes but I do not recall anyone talking about it in the local financial media. As I consider myself reasonably competent in technical analysis and have talked about the Head and Shoulders pattern and Using Fibonacci to identify potential turning points in earlier posts, I thought perhaps I should talk about the Death Cross and MACD divergence using the All Ords in today’s post.

Above is a daily chart of the All Ords. The Death Cross occurs when a shorter term moving average crosses below a longer term moving average. The commonly used moving averages are the 50 day (blue line) and the 200 day (red line). As you can see, we got our Death Cross in early June 2010, about a month before the S&P 500. This is a lagging indicator that confirms that a downtrend has already started. The opposite of the Death Cross is the Golden Cross. As you can see on the above chart, we got one on the All Ords in mid June 2009, about three months after the rally started.

The other pattern that can be observed on the above chart is the MACD divergence. MACD is a momentum indicator that measures how strong a trend is. When the All Ords came close to 5000 in Jan 2010, the MACD indicator was around 25 but when the index hit a new high in April 2010, the MACD indicator was a lot lower than 25 which showed that the rally has lost momentum and we got a 15 percent correction soon after. We can see another MACD divergence from June to August 2010. When the index was at 4600 in June 2010, the MACD indicator was well over 25 but when we touched the same level again in August 2010, the MACD indicator was well below 25 which again indicates a loss in momentum and therefore we can expect the rally to end soon.

Advanced technical analysis includes using Elliott Waves and market cycles to forecast market direction. Those who understand Elliott Waves well were able to forecast a rally in February 2009, just before the huge rally started in March 2009.  Correctly interpreting Elliott Wave patterns is not easy and there is a lot of work involved in studying market cycles. This is too hard for me so I pay to get this analysis by subscribing to companies that have the resources to do this like Elliott Wave International (EWI).

EWI does not just do technical analysis. They also study socionomics which involves social moods which have a big impact on market movements. For example, the sovereign debt problem has been there for years and no one worried about it. Suddenly social mood changes and the same problem which investors could happily live with one day, becomes something that causes them to panic the next day.

EWI also tracks investor sentiment and uses it as a contrarian indicator. When 98 percent of investors are bearish on something, then it is very likely that the price will go up as there are no sellers left. This was clearly the case last year when everyone hated the US dollar so EWI correctly predicted that it would go up. We see the same extreme sentiment on treasury bonds as 99 percent of investors are currently bullish on bonds, so they are predicting a correction soon.

Although I have classified EWI as a technical information source, it is more than that. Robert Prechter’s best selling book “Conquer the Crash” gives a lot of fundamental reasoning why he believes there is going to be a deflationary depression in the coming years. You can also get a lot of free information on Elliott Waves and Technical Analysis on the Elliott Wave page on this blog.

Leave a Reply