"Water shapes its course according to the nature of the ground over which it flows; the soldier works out his victory in relation to the foe whom he is facing. Therefore, just as water retains no constant shape, so in warfare there are no constant conditions."
Sun Tzu

Thursday, April 30, 2009

Technical Outlook S&P 500

I hope today is more than end of month sugar coating. Let's assume it really is. In that case, we might see a quick move up to the 925/950 area. Major resistance and the 200 day MA are waiting there around mid of May:

Wednesday, April 29, 2009

The Art of Trading: Momentum or Contrarian?

One way to classify your trading strategy is to decide if you wanto to trade momentum or contrarian style. Mechanical and discretionary approaches exist for both methods. For example, a short term contrarian methods based on the RSI (2) indicator, seem to be quite popular these days among various bloggers.

We also see trading methods work in certain phases of the market and failing in other periods, resulting in hedge fund blow-ups. Note that Victor Niederhoffer, a die hard contrarian investor, blew up two times. One of the reasons being a "black swan event", where a sudden strong momentum move kills the contrarian strategy.

During the Internet stock market bubble of the late 90's, a lot of new traders came in, who learnt to just play mometum. Most of them don't trade anymore today.

I believe that the key to trading success is a flexible combination of momentum and contrarian strategies. This is where trading becomes an art: the discretionary trader has to decide when to play which style. For example, two months ago, the market was selling off, comentators were predicting "Dow 5000" and negative sentiment was at the max. A perfect time to be a contrarian and go Long. Fast forward: today we are seeing a lot of plays on multi day runs in a pretty robust market (limited decline from Swine Flu news). This is probably more a momentum environment (look at restautrant stocks for example), where you want to buy what's going up.
The coexistance of the Momentum and Contrarian approach is one of the reasons, why I do not want to trade a mechanical trading system since they usually focus on a single style. I haven't seen any mechanical strategy yet (honestly, I didn't look very hard) that automatically adopts to these conditions.

Monday, April 27, 2009

The Current A/D Line Divergence

The market is currently shaping up a divergence between the NYSE Advance/Decline line and major indecees. Many resources, including the head of financial entertainment Jim Cramer, claim this to be a bullish sign for the health of the latest move:

I investigated the AD divergence phenomena over the weekend and came up with the following statistics:

Sample size is fairly small with 19 observations in the last 17 years, so we have to be careful with drawing any conclusion from these results. In any case, in 52.6% of observations, the market behaved accordingly. (E.g. positive divergence: market moves up afterwards). Overall not too
impressive, especially if you look at the positive/negative divergences seperatly.

What's interesting, though, is when a negative divergence occured after the market went up. Prediction was correct in 83% of the cases with 6 observations. I would like to have a larger sample size before placing any bets on this. I keep observing...

Based on these number, the statment "positive A/D divergence is bullish" is not valid.