All You Need... is a Chart

[firewalker]

This is my first post on TL and I hope it will be start of something refreshing. I've been a member of T2W, having learnt a lot over there, but recent turnoil and lack of interesting discussion made me leave that site. I won't be posting as much as I did over there , I'll focus on developing my own blog instead and will hope to learn something more along the way.

I would like to continue one thread, which I started two weeks ago, but unfortunately got derailed so many times that ultimately there was no point in doing so. From what I've seen, the odds of this happening here are next to zero, thankfully.

[firewalker]

In this thread I'll discuss why traders don't need to study anything other than a chart. I will try to illustrate that every news item, corporate report, monetary decision, in short anything fundamentally related to the economic situation of a stock or market, is printed on the chart first, long before the public becomes aware of it.

"The tape tells the news minutes, hours and days before the news tickers, or newspapers, and before it can become gossip. Everything from a foreign war to the passing of a dividend; from a Supreme Court decision to the ravages of the boll-weevil is reflected primarily on the tape." -- Richard Wyckoff

Undoubtedly people will tell me this can't be true, otherwise why would we have market analysts? Why would the newspapers print financial pages? The purpose of this thread is to inform, not to convince any disbelievers. All you need, is painted in the chart. Several concrete examples will be shown to support my case. The topic is open for discussion, but I hope this thread can become more than an evocation of "this is my opinion" posts. If you feel strongly about something, back up your point of view with some arguments.

Here's to the wonders of the chart

[firewalker]

Some traders are very anxious on the lookout of news, be it earnings season, rate cuts, important economic indicators, non-farm employment...

Before we talk about the effect news can have on the market, we'll enumerate four different possibilities:

(1) Good news comes out but the market fails to go higher: consider this to be warning signal.

(2) Good news comes out and the market rallies: could be positive, but buying on good news is often a risky thing to do, because smart money will try to unload when the public is buying in a frenzy.

(3) Bad news comes out, the market plunges: this often leads to a short lived down move. The public dumps the stock and believes the state of the business (or the economy in general) is getting increasingly worse. Smart money can easily pick up shares at low prices without driving price higher.

(4) Bad news comes out, the market doesn't drop: consider this to be a sign of strength. If the market fails to go lower on bad news, it means the worst is usually over and the news has already been fully discounted in the prices of shares.

[firewalker]

There is one important element still missing from the previous post, and that is "time".

Good news is omnipresent near the end of the bull market phase, usually characterized by a parabolic rise in price. This is one of the rare occasions that buying on good news might lead to profits, because price tends to continue in that direction in this phase of the market cycle.

Bad news, and "catastrophic news" comes out near bottoms. Selling on bad news usually means you'll be selling too late. This is not to say that prices can't go lower, but when bad news is released, the market already knows about it.

Therefore the first important rule here, if you want to play it safe, is to avoid trading the news. There are too many variables in play to determine what will happen seconds before the report or on the moment of the release itself. However, if you're in a position already, I'll show you there are a number of elements that have a high probability of assessing the initial reaction of the market.

The second rule is to pay attention to the reaction to the news and play that reaction technically, with complete disregard to the economical indicator, be it better or worse than forecast.

[firewalker]

The purpose of this thread is not only to discuss theoretical concepts, but to illustrate with practical examples too.

The first example serves to show that the market often tricks the public into buying on good news. Unless a technically important level (like support or resistance) is breached, the market often returns to it's previous trading level after the news. I know of traders who specialize in trading these 'news reversals'. The important however, is determining the odds that price will not reverse.

The third rule I suggest is that you scale out or exit your position if price moves in the desired direction on news. Scaling out gives you the opportunity to lock in profits quickly in case the news turns out to create a sharp spike. By leaving a part of your position open, you open yourself to the possibility that price continues even further.

The attached charts all illustrate this concept. The huge volume peak is where the news came out. Notice how in each DAX chart price returns to it's previous trading level and continues as if nothing was going on. I'll provide more recent charts in the following charts. These are some observations from in my early days. The two charts look very similar, but I can assure you they are from a different date and different context.

[firewalker]

"I would like to know if it's possible to predict the direction before a news-event?"

If you're talking about news reports or sentiment in general, I believe yes. For example, price was distributing on the major US Indices near the end of last year and made a lower high before the whole subprime crises became in the popular media and before all the financial institutions were screaming for more liquidity from the FED.

As for singular news-events, it's not always that clear. I believe this is in part because of the manipulation that it possible on smaller timeframes, and in part because so many people focus on trading around these reports. This can create some whippy action that catches both sides out.

Attached is a chart of an important news report (FOMC if I remember correctly). Notice how 'technical' price reacts. Yes, anyone trading this would need very wide stops, but in the first spike price bounces back higher off the lower support area. And in the 30 minutes after the initial release, all price bars (5-min chart) continue to close above support, indicating where the buying pressure is to be found.

[firewalker]

This happened only a week ago, and at the time - rather than at the end of the day - I described what I would do, depending on the market action. It underlines the importance of having predetermined scenarios, so that you'll know what to do, when you see it. Anyone reading this, should position themselves "in the flow" of the moment.


Within a couple of minutes we have the 'ISM Non-Manufacturing Composite' number which will have a definite affect on the markets. By determining beforehand what action is possible and where this action takes place, we can position ourselves better.

Now, there's not much time left (7 minutes) but I'm typing this as we go along.
Attached is a DOW futures chart, with important support and resistance levels drawn on the chart. I have 13030 and 12930 as resistance and support, the midpoint is 12980, which is often an important area where price returns to, when trying to find value.

Notice how on Friday price went slightly below 12970 but kept very much around the 80 level. Also today, since the open we moved lower and touched 12977 before going up again slightly. A long entry would be fairly aggressive there, but it's possible...

Now, what do we look for?

(a) if the news is bad, we'd expect price to go lower, but we'd like to see buying come in around the potential support at 12970. Going long immediately would therefore be risky, but if we get confirmation that price is holding support (for example by first spiking through it but then closing all the way up again above support), this could trigger a buy signal.

(b) if the news is bad and 12970 is broken straight away, we stand aside and wait for price to find support lower (preferably around 12920-12930)

(c) if we move up on the news than we missed our entry, but too bad. Then we wait and see how price reacts to resistance at 13030 and see if we get a short signal.

ym_20080505.GIF

==============

And this was posted immediately after the news, after I made an entry:

The ISM number was 52, better than forecast. So we spike up... but, this is a spike into resistance. Now, like I said we wait to see what the reaction to 13030 is. However, by waiting I don't mean minutes, because by then the chance to get in early will have passed. That's why I attached a blow-up of the action, a 15-second chart. Notice how the bar closes at 13029. Coincidence? Of course not. This is where selling pressure comes in.

If you look at this from a 1-minute bar or 5-minute it's still easy to see that price fails at this level. Although, the longer you wait the less obvious it's going to be that a nice short entry presented itself, with a stop around 13040 or so.

Now, forget about the news for a minute and just observe. How does it help you knowing that there was news and what the figure was? It doesn't. The fourth rule therefore is that you don't need to know what moves the markets, you only need to see the resulting action. Whatever the cause, price is being pushed down because there's a lot of supply at that level. The volume is huge, price fails, what more do you need to know? This doesn't automatically mean price will plunge, but at least you have a trade that you can ride back to the opening low, where you should expect price to find support again.

This example is meant to illustrate that the cause of what happens is irrelevant. Even if this would turn out to be a losing trade, it doesn't change the fact that you can see everything you need from the chart, without looking at the news.


ym_20080505_ISM_15sec.GIF

========

Anyone looking back at this day, without knowing when the ISM report was released can still see the high volume and the rejection of resistance. What matters is what you see in front of you, which is the effect - the net result - of the sum of all buyers and sellers. Knowing who is moving price or why price is moving in a certain direction, should not be our concern, unless we want to become financial analysts, instead of traders.

Note: below is a chart of the whole day so put things in perspective.

ym_20080505_day.jpg

[firewalker]

A comment I received (dcraig1): "The fact is that mutual funds, unit trusts, investment trusts and pension funds are primarily managed by fundamentalists. Those who will tell you that for example fibs work because "lots of traders look at them", will then say fundamentals don't count ignoring the fact that fund managers swinging a bigger stick primarily make their decisions on based fundamentals.
A lot of big fund managers trade based on fundamentals. After all, it's big money that creates a pattern on the chart in the first place. This is why a fundamental shift in the economy comes out in the stock market (a chart) first, before it's translated into an economic indicator or a company report. Technicians look for these signals, perhaps through indicators or through price/volume movement, but they aren't responsible for initiating the moves themselves. This doesn't change the fact that fundamentals come out in the chart first."

Below is my view on fundamentals. I'd love to hear what others think obviously. Feel free to disagree!

Those who look for 'fundamentals' are usually looking at either - depending on whether they trade an ETF/index or a stock - statistics about the economy as a whole (GDP, CPI, interest rate, trade balance,...) or statistics about the company (P/E, dividends, earnings, projections,...). They forget that these numbers are nothing but translations of something which has happened before, these are by definition lagging indicators. Therefore, by following the fundamentals you are always two steps behind.

The market turns upwards or downwards because those with the big bucks have determined that the current prices are not correctly related to, what they perceive to be as, their fundamental value. But 'fundamental value' isn't translated into an indicator that comes out two or three months later. Which is why all those who think they study fundamentals, are only studying the effects of a fundamental shift that already took place.

A stock that is basing, is exhibiting patterns of accumulation because a select number of people (with "a bigger stick") perceive it to be lower then the real value. They believe the 'fundamentals' of that corporation are fine. But at this moment, the news is usually bad, earnings are worse than expected and jobs are being cut. The accumulation pattern however, comes out in the chart before - usually couple of months later - a rise in earnings or a increase in sales becomes public knowledge.

Yes, fundamentals have a casual relationship with price, technical analysts don't move price. It's not because a trendline breaks or an MA crosses over (or a Fib line is drawn somewhere on a chart) that price will move lower. Fundamentals are the driver behind the markets, but technicals are what helps you determine in which direction the market is moving, before the fundamentals become common knowledge.

Whether or not mutual/pension funds are managed by fundamentalists or technicians, I couldn't care. Fact is that a lot of hedge funds lost loads of money in the last year, pension funds continue to stumble and 'the professional money' has to fight with other professional money as well. It's not because it's big or professional money, that's it's per definition smart money all of the time.

[firewalker]

"Most people look at the state of the economy and believe that the stock market should mirror the current situation. They believe that a strong economy should correspond with rising stock prices. Unfortunately, the relationship is not that simple. The stock market discounts the future, not the present. It discounted the present 6-12 months ago. [...] In fact, the stock market is one component of the Index of Leading Economic Indicators, the government's main economic forecasting gauge. In other words, the stock market leads the economy, not the other way around."

- Jack Schwager in a book called 'Fundamental Analysis'...

[firewalker]

... regardless of the news.

People often look for the news to tell them what the market is going to do. Good earnings? Ah, market should go up, we buy! Bad news? Damn, let's dump this stock. Although we can never tell with 100% certainty what the initial reaction to the news will be, we can analyze the reaction of price towards technical levels, with complete disregard to what created or caused the move in the first place.

Those who follow stocks, will know that Cisco released it's Q3 report on May 6, around the close of the markets. Let's have a look at what affect it had on the Nasdaq.

Price went straight up from 1995 to 2002.50 and went on to touch 2005, the upper line of a resistance zone from the 2nd of May. Price then reversed and came back to the level it was trading at before. So, what good does it by knowing the news? If anything, the public is sucked into longs but doesn't realize 'the technical picture' on the chart.

There are plenty of these examples each day. I'm not saying there is a news reversal all of the time. On the contrary, price often breaks through S/R on news, because that's the easiest way for the smart money to position themselves. The take advantage of what the public is doing and use the volume provided by weak hands to their advantage. The news is nothing more than an excuse.