Technical Analysis - Should Long and Short Signals be Mirror Opposites?

Over the past few decades with improvements in computer technology, trading systems based on technical analysis have gained in popularity. A technical trading system can be defined as a set of rules based on the movement and changes in price and volume of a financial instrument(s), which are followed to make decisions on when to enter a market position (long or short) and when to close or exit a position. A technical trading system does not necessarily have to be a set of rules that can be automated and executed by a computer, but in fact can involve human judgment (such as drawing trendlines, detecting chart patterns etc..). While the continuing emergence and improvement in trading software has allowed more and more people to test their hand at developing technical systems, the vast majority either quit due to the frustration of little success or are forced to quit due to a significant loss of capital. However, this is not to imply that attempting to develop a profitable trading system is futile, but instead that in order to be successful one must show serious dedication, keep an open mind and think outside the box. In regards to technical trading systems, one way of thinking outside the box is by examining a point which is rarely discussed in the literature on technical analysis. This is the question of whether the signals for long and short trades should be mirror opposites.

Bailouts Won't Return the Economy to Prosperity

Times of social crises are when governments take their most drastic steps, and the economic collapse which began in 2008 has been no different. While many have called for governments to step away from the economy and let markets solve the problems, politicians will allow no such thing. Instead one of the most common themes of the current economic crisis has been government bailouts, occurring not just in America, but in nations across the globe. Trillions of dollars have gone to banks, insurance companies, car manufacturers, and most recently close to a trillion dollar package was put together in an attempt to "save" certain European nations. Government officials, as well as the majority of talking heads represented through the mainstream media streams, seem to believe that these steps, or interventions into the economy, are necessary in order to prevent a devastating collapse, and that furthermore, it is this type of action that is needed to return us to prosperity. However, this belief simply does not reflect reality, as these bailouts (and the increased government intervention into the economy as a whole) are making the problems which plaque the global economy much worse, and delaying any true economic recovery from taking place.

Two Obstacles of Fundamental Analysis

The most common form of analysis used by investors and traders to aid them in their investment decisions is fundamental analysis. Fundamental analysis is essentially the process whereby one analyzes the fundamentals of a company (financial reports, earnings reports etc...), certain sectors and markets (auto sales, oil inventories, housing starts etc...), and the economy as a whole (GDP growth rates, unemployment numbers, interest rates etc...) in an attempt to discern whether a stock, commodity, industry, or the overall economy is likely to endure a bullish or bearish move over the time horizon with which the individual invests. Fundamental analysis is used by most in the retail investment industry (i.e. stock brokers, wealth managers, and financial advisors) as their exclusive means for making investment decisions. Furthermore, most universities and colleges as well as those in the mainstream media portray fundamental analysis as really the only realistic manner to invest in the markets. However, there are two serious obstacles, or flaws of fundamental analysis that must be overcome if one seriously expects to be profitable over the long run. The first obstacle relates to the problem of timing ones entries and exits, while the second obstacle relates to the problem of discerning what the important fundamentals are and how to interpret them given our increased understanding of the behavior of complex systems, which both the economy and financial markets can be classified.

The Beginning of the Economic Crisis - August 15th 1971

The economic crisis that began in 2008 is by virtually all measures the most serious since the Great Depression. The severity has led many people to the realization that significant change is needed as this economic downturn is not cyclical, but structural. While there is much debate and differing opinion on how to return the economy to prosperity, there are two ideas which dominate the views of both politicians and those in the mainstream media. Firstly, it is believed that the government needs to increase their role in the economy through higher levels of spending, job creation, and regulation. The second main idea, which is complimentary to the first, comes from those in the monetarist camp, and is the belief that an economic downturn can be solved through an appropriate increase in the money supply. Given the prominence of these ideas amongst politicians, central bankers, and other government officials, it is no surprise that the programs which have been implemented thus far, such as the bailouts, stimulus packages, as well as Federal Reserve and Treasury programs, are primarily based on these premises. However, the fact of the matter remains that the economy has shown no real signs of recovery, and this begs the question; do those in power even know what they are doing?

When to Abandon a Trading Strategy

No matter what method you use to trade the markets, be it fundamental analysis or technical analysis, there is one common element all must master if they hope to be successful, the art of discipline. Every day a traders discipline is tested as they watch the price of financial instruments fluctuate and feel the emotional urge to enter or exit a position, even when they know from their knowledge and experience that it is best to suppress such urges. However, there is another type of discipline that is required for a trader to become successful, which is especially applicable to system traders, but applies to anyone who uses a predetermined trading strategy. That is the discipline to know when to abandon or change a trading system's rules because they are resulting in poor performance versus when to continue or give the technique more time in its current form as it may just be that the system is experiencing an inevitable period of drawdown.

Inflation versus Deflation - The Case for Deflation

Over the past year, the stock market has seen a strong bull rally off of its March 2009 low which has certainly been great for many people's investment accounts. Unfortunately, it has also led many in the mainstream financial industry (media taking heads, traditional brokers, large bank economists, politicians etc..) back to the same level of blind optimism and complacency that was seen prior to the 2008 crash. Investors who share this complacent view of the market are likely in for another shock because before the economy can return to real growth and prosperity much of the malinvestment that was built up over the years of low interest rates and easy money must be cleaned out of the system. The government and Federal Reserve Bank have been implementing significant measures to try and prevent this natural economic process from occurring, however, the economy is too large and complex to be controlled by a handful of individuals. Most of those who are proponents of free markets will likely agree that the large amount of malinvestment in the economy will inevitably lead to another crash, and one that is likely bigger than that experienced in 2008. However, there is currently an interesting debate between those who believe that the current state of the economy will lead us towards a period of strong inflation (possibly even hyperinflation) and those who believe the opposite will occur and we will instead see deflation. The occurrence of either significant inflation or deflation will have serious and drastic effects on all areas of the economy. Although that being said, a period of strong inflation will result in the financial markets performing in a much different manner then a period of strong deflation. Inflation will lead to a significant nominal rise in the price of real estate, commodities, stocks, and virtually all other asset classes other than the dollar, which will decline in value. While a period of deflation will see a decline in the price of almost all asset classes and a rise in the value of the dollar. As such an investor who can correctly anticipate which of the two scenarios will play out will put themselves in a position to profit handsomely.

The Effect of Changing Market Psychology and Volatility on Technical Trading Systems

With the rapid advancements in computer and internet technology, technical trading systems are one of the more realistic means an individual trader has at obtaining long term market success. A technical trading system can be defined as a set of rules, based primarily on the movement in the price and volume of a financial instrument(s), which are followed to make decisions on when to enter a market position (long or short) and when to close or exit a position. A technical trading system does not necessarily have to be a set of rules that can be automated and executed by a computer, but can involve human judgment (i.e. drawing trendlines or detecting chart patterns). To be successful investing in a traditional manner (i.e. fundamental analysis) requires access to significant amounts of information about individual companies, sectors, and the overall economy, which is sometimes difficult for those who are working on their own to obtain in a timely manner. However, developing and trading a technical system only requires access to historical market data for the development of the system, live data for the trading of the system, and a computer program to develop and test the rules of the system, and these things are all easily accessible to the average trader.