Trader’s Narrative

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Granville said it best in his book, A Strategy of Daily Stock Market Timing:

“When it’s obvious to the public, it’s obviously wrong.”

Since we talk a lot about sentiment and contrarian sentiment, lets step back and review where this idea came from and how it developed from its origins.

Charles H. Dow
The main principle behind contrarian analysis and sentiment (two sides of the same coin) comes from Charles H. Dow’s work on distribution and accumulation. The same ideas that underpin the Dow Theory. I’m sure you’ll also notice the similarity between these ideas and Weinstein’s stage analysis which breaks up a movement of a security into four parts.

According to Dow Theory, major market movements start with an “accumulation” phase where insiders, and other knowledgeable traders or investors start to buy shares. Since at this point the average public sentiment towards the market is negative, they are able to accumulate shares without significantly pushing prices higher.

Eventually the general sentiment starts to tip as more and more people start to realize that something has changed. This is the stage at which trend followers jump on and start to push up prices further. The trend continues and feeds on itself, perpetuating until it reaches a crescendo.
Continue reading ‘A Brief History Of Contrarian Analysis’

The “Smart Money Index” was created and popularized by technical analyst Don Hays. It is also sometimes known as the “Last Hour Indicator” because it compares the first hour of trading in a day to the last.

The theory behind such a comparison is that the market participants vary in these two time periods. Since the retail crowd usually reacts to prices after the day’s close, their trades are processed during the first hour of the next day. And since the professional traders watch the whole day unfold, they are the ones that take, or pare, positions overnight, depending on the risk exposure they desire.

Here’s a chart of the Smart Money Index for the Dow Jones from 1986 to 2005:

So by comparing what these two disparate groups are doing, we can attempt to gain some insight into where the market may be headed. For example, if over a period of time the amateurs are buying while the professionals are selling, this indicator will fall showing that distribution is taking place. Which is what we saw well before the infamous 1987 market crash - as you can see on the above chart.

But hat gives this indicator its power, is also its weakness: it can lead the market well in advance… from months to almost a year. So it makes it hard to actually time an inflection point. All we know is that one is coming.

So what is it saying now?
It is difficult to decipher this indicator because it doesn’t have absolute levels. But at the same time, during this most recent decline, according to the SMI, while prices have been falling, there has been an accumulation going on behind the scene.

That is to say, while the market has been declining, it has generally opened poorly (gap down or negative during the first hour) to close strongly.

MarketTells by Rainsford Yang
The SMI chart for the Dow Jones comes from MarketTells analytic service. I’ve heard very good things about them so I’m going to check them out and write a review for my readers. There are so many undeserving market services out there than when I discover a gem, I am happy to share it to help out others.

I subscribe to other similar services, like SentimenTrader.com which also covers the SMI index. I didn’t want to include a recent chart of the SMI showing its rapid rise because it would be unfair to Jason Goepfert to give away his fantastic work for free.

You can always take a free, no obligation, 14 day trial of SentimenTrader to see for yourself. Full disclosure: I am not an affiliate with either site.