Sunday, July 23, 2006

Heads and Shoulders

No not a special deal on shampoo :) Everywhere you look across the stockmarkets there are head and shoulders formations or closely related chart patterns. One of the most prominent is on the Dow. The implication is a fall to around the low of August 2004. In Elliott Wave terms the move down from the top is an ABC (or WXY) pattern with the wave C ( or Y) down just getting started. I and Volkmar Hable both think there will, however, be a rally in the coming week, which on the NASDAQ and SPX indices will complete wave 2 of this C wave, an upmove which started some time on Tuesday.

Will the head and shoulders correction be the end of this current short-term bear market? It is impossible to say but I think there is a strong probability that it will be. Most bears are looking for a low in October or even 2007. What most people are looking for often doesn't happen. I'm now thinking that this year will turn out to be more like the mid-cycle slow downs in 1985 and 1995 rather than a full blown recession and the market might act more like 1987 (but without the dramatic crash) or 1998 - i.e. a short, sharp correction over a few months. This is partly based on trying to fit Elliott Wave patterns to various foreign stock indices. It's hard to believe that their rallies since 2002-3 are corrective in nature rather than bull market impulse waves. If the latter is true then the current correction is just wave 4 of an ongoing bull-market and the market should not go below the 2004 (e.g. FTSE, DAX) or 2005 (in Australia) highs in these indices.

Learning from your mistakes is one of the most important habits of successful investors. So I have been busy analysing where I sent wrong in the last few days. I've come up with at least one or two useful additional trading rules. Also it is clear that some times my technical analysis tools and model give trades with higher probabilities than others and the size of the trading position needs to be modified accordingly.


Anonymous said...

Regarding your trades, did your "model" loose money or did "you" loose money. Small distinction but still an important one I think. If your model signaled the moves but you lost money then maybe your model is okay. If it's the other way then you probably should revisit your calculations.
Also would taking fewer trades increase your yield by making you wait for the better signals?
WRT the HS pattern and the market outlook in general I find that it is really difficult to call with certainty regularly (for me at least) when the trend will reverse. Though you seem to so far be doing a good enough job if it.
Justin Mamis in "the nature of risk" puts it well- at one end of the spectrum is mostly information risk and minimal capital risk( as a violation of the preceding low should trigger your stop) and at the other end is maximal capital risk and minimum information risk(everyone now knows that a rally/bull is in place) but the logical stop is so much further away. The trick I guess is to try and figure out the area close to the first part above.

mOOm said...

The model lost but, I did too but not each day. All trading models will lose money at times as a lot of what happens in the stockmarket is random. Efficient market theory says it is all random... all one can do is look to see anything systematic and add that to the model.

Interesting idea about risk. The biggest risk is from unexpected negative shocks like 9/11. My model was short then but the next event might happen when one is long. Endogenous market crashes don't come without warning.