January 8th, 2009

Objectively Understand Your Trading Style

My wife is my most consistent critic and skeptic but rarely reads this blog (I welcome your sympathies). She asked me today “If your charts are so reliable, why didn’t you foresee today’s 250 point drop, a drop that wiped out all of 2009 YTD gain?”

Well, this underscores (as far as I’m concerned) a major blind spot many people have when they think they’re doing smart technical analysis. That blind spot is looking charts in only one time frame and usually ignoring the longer term picture. Most newsletters and blogs take a very short term view. They see today’s move in the market and many industries and stocks as “rolling over”. To them, this is the beginning of the end.

First, let’s put today’s market into perspective with a look at the S&P 500 Index. Only yesterday, I wrote (click here to see chart):

…..it becomes obvious that we’re in the earliest stage of this bottoming process. In all likelihood, there will be a retest of the November low and it may or may not hold. What can be said, however, with some confidence is that the Index will not rocket through the remaining moving average benchmark hurdles without some retracements and retesting.

It’s imperative to point out that today’s decline, although 3%, stopped right above the 60-day moving average which has turned up itself after trending down since June, 2008. That retracement may have begun today and there may be additional 5-6% decline to 850 – but perhaps not further.

One of the online newsletters to which my wife subscribes is called Trending123 authored by John Lansing. Today, he gave gold as a short saying that gold’s patterns includes several “lower highs and lower lows” implying to him, as he looks at that chart, that gold is headed lower. Sorry, I couldn’t disagree more. Here’s an updated chart of the gold ETF (GLD):

Yes, I see the lower highs and lower lows but saying that means a major decline in the offing is, i believe, wrong. What this analysis ignores is looking at trends prior to the current pattern. When you do that you see a fairly reliable 10-month bullish flag pattern. Note also that the previous low came to a rest at a trendline connected to the 2006 high.

If it turns out that a bullish flag pattern is being formed (rather than the early phase of an emerging top formation with that trendline being a neckline to either a double top, etc.), then a more reasonable forecast is a major bullish breakout of the flag with a move equaling the percentage leading up to the flag, or a double to 140-150.

I guess it has to do with the intensity of your trading style and your tolerance for volatility. Mine is longer term and I willing to establish a position which has a high probability of doubling than worrying whether I’m going to suffer a 10-20% unlikely temporary (2-3 month) retracement. Bottom line, whenever you read or hear market comment, do it with a clear understanding of your trading style.

Subscribe below or click here to learn more about help for navigating turbulent markets.