We’re All Technicians Now

Found by Shaza

I’m stating the obvious, but signs of newly minted chartists are all around.  Markets break major levels and continue on before violently reversing the next day.  TA practioners(like me!) can start a site and in days have a forum for conveying market views.  Heck, I had to sit upstairs at the Market Technicians Association 2010 Symposium because the entire lower level was jammed full of technicians young and old.  A year ago, the event was free and I had room to stretch both ways.
Don’t get me wrong…I’m glad people are adopting technical analysis in droves, as I believe price action is more honest than most CEOs.  At 3500 or so, MTA membership is still dwarfed by the fundamentalists at CFA.  But I can’t help thinking that the attraction to moving averages and support/resistance lines is partly responsible for the manic behavior of stock prices.
This article from Mark Hulbert(ht @zortrades) highlights just how quickly sentiment can change.  His surveys show newsletters recommending an average allocation to NASDAQ stocks of -45%(yes, minus), down from +80% two weeks ago.  I’ve tracked this stat for years, and can find no instance of such a dramatic swing.  I know new risks have been introduced, but was the fundamental case for stocks really that good in March and April?  Throughout 2009?
This is a momentum-driven economy, almost a perfect example of the reflexivity discussed by George Soros, where the action of the participants themselves creates the change they anticipate.  It was that way in 2008 to the downside, in 2009 to the upside, and 2010 has been more of the same.  That massive rally from the February lows? It was one giant IBD-style trade, just as easily exploited by buying calls on the Russell 2000.  The peak and plunge in May? Same thing, all one trade driven by intermarket relationships.
My prescription for this momentum madness?  Acknowledge it.  Realize that while a break of the 50 day or 200 day average may be more significant that day, much of it is driven by portfolio managers newly converted to the trend following altar.  That doesn’t mean fight them, it just means expect those breaks to pick up steam as more eyes watch and react.  It also means the latter portions of those moves are really weak hands, so after confirmation that the move has been reversed there will be huge amounts of regret and fear of missing the next move.
Watch the 20 day MA if that’s your time frame, but why not track the 15 day and 25 day as well?  If everyone is using the same indicator, it will work spectacularly for the day of impact and poorly thereafter.  I like to watch the battles at the 10 Wk(50 day), because it leaves good clues as to the intentions of large buyers and sellers.  But I recognize that, in this market, a .20 break of the 50 day probably becomes a $2 break that looks disastrous…at which point we get fixated on how “broken” the stock is.  But like the Flash Crash, it may have just been many extra stop losses sitting just beneath(or above in case of downtrends) the popular numbers.  Once the smoke has cleared, the natural flow of buyers and sellers resumes.
Styles have peaks and valleys…like the 1970’s, strategies using technical analysis have become very attractive to advisors and investors seeking a way to thrive in a rangebound decade.  Welcome aboard, I say…at the very least, it forces users to be aware of risk before news arrives.  And transactions costs have gotten so low that it costs very little to re-enter if your original stop loss proves to be a fakeout.  It’s easy to stop yourself out…what’s hard is re-entering an idea once it reasserts itself.  Understanding this ahead of time is the most important tool in your kit