Delusions - Why technical analysis works - 1

A few posts back I alluded to the "self-fulfilling nature
of technical analysis". I will start the series with this
post. I couldnt think of a clever name for it!

Please look at the chart of the S&P500 below and read my
comments in the right margin.



The S&P 500 has been in an uptrending channel since the
"Bear Stearns bottom" on March 17. Thats when the Fed
made a signal statement of the kind they rarely have in
the past, viz, "We will NOT allow the market to collapse".

Of course, what impact that will have on inflation, and
whether inflation will ultimately destroy whatever
little gain can be had from the Fed-supported stock
market, is a whole different story!

Anyway, I have a few points to make, and here they are.

1. Do you think the index has been supported by the
uptrend line or the 20-DMA ?

2. Was the index turned back at the start of May from
the 200-DMA or the top of the uptrend channel ?

3. Is the RSI holding above 50 for the last month or
so a sign of strength?

4. Is it time to rejoice now that the MACD has crossed
above the ZERO line?

I will give you the answer to these questions. The
answer is "Your guess is as good as mine". But thats
not the whole point of the story.

The point of the story is that these technical
parameters and events are what is used by the majority
of program trading systems which have such a huge
impact on the market these days.

And thus, the reason why technical analysis works
is not some inherent magic in moving averages, channels
or anything like that. It works because of the same
principle which would have allowed you to double
your money many times over if you had bought the
Dow 50 years ago and sat back and done nothing
since - the "herd principle".

You will go only so far with the "herd principle",
and that too when you are good enough to be on the
side of the majority herd more often that not,
which is no easy task. Maybe you will make 10%
annually with some consistency, and pat yourself
on the back for you would have beaten most overpaid
money managers on Wall Street. You will most assuredly
NOT make the kind of returns I do on a regular basis.

Times are changing. Events of great significance are
taking place. There is more money in the swap market
than in the stock market. Commodities are no longer
the playfield of commercials and speculators, but
of investment-minded pension funds! The "herd" which
ran things are finding themselves out of their depth!
Will you be able to choose the correct herd?

There will always be a place for technical analysis.
We need to understand what the herd is thinking.
But we certainly do not need to trade like them!

Thanks for your viewership!