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Thursday 26 June 2014

Counting Cards

I've had quite a few new readers in the last few months and it struck me yesterday from a couple of comments that at least some of these were obviously still hazy on the distinction between technical analysis and fortune telling. It can be an easy mistake to confuse the first with the second, as a good analyst can sometimes make calls that seem almost supernatural. Some of my past calls have been amazingly and rapidly accurate, and some offhand examples I'd pick would be:

  1. My June 2010 call of the low area on BP just before the end of the wild decline after the oil spill, 
  2. My February 2011 call of the inflection point area on TYX (30yr Treasury Yields), days before TYX reversed at channel resistance and started a decline halving the long term bond yield over the next 18 months
  3. My November 2012 call to short the Yen just before it declined over 20% over the next six months
  4. My June 2013 call for SPX to rise to 1965

There are many others that I should really list on a page on my blog at some point, but my point here is that while this sometimes may appear to be magic, it's actually just good technical analysis. I don't have any supernatural powers, and I cannot see into the future. Any setup I show, however impressive the historical precedents, can go the other way, taking a lower probability path. I have no magical power to see into the future. No technical analyst does.

At school I used to supplement my pocket money by counting cards while playing blackjack for money. It's not an easy skill to learn, but if you can do it you can tilt the odds into your favor to a degree where over a period, and on average, you can win reliably. That's why they watch out for card counters in Las Vegas, and ban them for life from casinos as soon as they are identified. Casinos don't want customers who can turn a game of chance into a game of skill. That's because they don't like losing money, which is fair enough.

Technical analysis is akin to counting cards at blackjack. You can never know what the next card dealt will be, but it is a skill that can tilt the odds in your favor to a significant enough degree that you can beat the market with a reasonable degree of consistency. Unlike casinos you don't get banned from exchanges for using it, which is why trading the markets can be a game of skill in a way that playing blackjack in a casino can't.

When I was looking at the setup yesterday morning I warned that the bears might collapse at the open, that a break back over the the SPX 50 hour MA would badly damage the chances of more short term downside. I flagged a break below the rising channel on TRAN as important for opening up the downside. I tweeted after the bullish open that we might see a retest of the highs. Nonetheless some readers seem to have condensed everything I said into 'market-go-down-now', and were disappointed that didn't happen. Alas, that just isn't the way it works:
Equally the strong recovery yesterday doesn't actually change much, and those who have concluded from it that the market will power up directly through 2000 from here over the next few days are just as likely to be disappointed as they were at the start of the week. Not only are significant tops often signalled by declines just beforehand that are quickly reversed amid premature celebration parties thrown by bullish ignoramuses, but neither a 61.8% fib retracement of a decline nor a retest of the highs are inherently bullish, and are both frequently part of a topping process.

The main obstacle for the bull side here remains the same, and that is very strong resistance at the primary rising channel resistance trendline slightly above the current highs. That could break of course, but until it does it is rising at about 15 points per month, and potential upside is limited to that. The SPX weekly chart:
Are we definitely going to make a significant high here? No, anyone with a guaranteed forecast can be reasonably assumed to be a fool or a liar. There are no guarantees. What I would show today though, in addition to all the other various historical precedents that I've looked at over the last week, is the daily SPX chart with the marked divergences against the daily NYMO, and the SPX daily RSI 14 and RSI 5.

I think we can all agree that the period from the start of 2013 has been unusually bullish by historical standards, so I've started this chart there, and the eight shaded areas on the chart are the areas where SPX has positively diverged from NYMO and either or both of the RSI 14 and RSI 5. There are seven previous instances over this very bullish period and the smallest retracement after these previous seven instances was about 2.2%, which if we were to see that minimal retrace here, would target 1926 SPX, a key retracement target that I've been looking at and also the target on the possible double-top that would form if we were to see a retest of the 1968 high. No guarantees but just sayin'. SPX daily chart vs NYMO and RSI:
The main options that I am looking at today are that either we saw a 62% retrace of Tuesday's decline yesterday and the decline will resume early today, possibly after a retest of yesterday afternoon's high, or that we will see a retest of the 1968 high, making the second high on a double top targeting the 1926 SPX area. After either we should decline again, with the obvious first real target at a retest of the 1926 low SPX 60min chart:
TRAN pinocchioed the rising channel support trendline near the open yesterday, but it didn't break, and the small double bottom failed on the bounce. That was disappointing as that channel is most likely going to need to break soon to allow a decent general decline. I am watching the chart and seeing if I discern a context for the current move. TRAN 60min chart:
TNX is still in the inflection point that it has been pinned in for a while now. As and when it breaks this should signal a big move in the direction of the break. Short term TNX tested possible double top support yesterday and it has held so far. TNX 60min chart:
I posted a bearish looking USO chart yesterday morning and would add that if we were to see a decline on oil here, then the ideal signal for that would be a marginal new high in the 108 area to establish negative daily RSI 14 divergence. I'm in two minds about this chart as the rising channel is strong and the bullish triangle target is still open, but the price action in recent days hasn't been particularly encouraging, and whatever it is that Al-Qaeda/ISIS are doing out there in Iraq, it hasn't been bringing home the bacon for oil bulls so far. WTIC daily chart:
What are the odds that the primary channel is about to break up? Well a lot higher than your chances of being killed in an asteroid impact, which are themselves a surprisingly high 1 in 700,000. Looking at the history I'd give the odds to this breaking up at all at perhaps 25%, but it's important to remember that while that means that I think that there is a 75% chance that the channel will hold, I am assigning a 25% chance that it won't, even if that's as high as 25% only because I too have been very impressed by the tenacity of this energizer bunny of a market.

Barring that though, and I suspect strongly that the chances of a break up are lower than 25%, and in any case that wouldn't be 25% odds of it breaking up right here and now, which I'd put at no more than a generous 10%, then the main options are the ones I laid out above, which I'll repeat below:

The main options that I am looking at today are that either we saw a 62% retrace of Tuesday's decline yesterday and the decline will resume early today, possibly after a retest of yesterday afternoon's high, or that we will see a retest of the 1968 high, making the second high on a double top targeting the 1926 SPX area. After either we should decline again, with the obvious first real target at a retest of the 1926 low.

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