Trader’s Narrative

Apologies for the late posting so far this week. I was away at a family wedding and missed the regular scheduled posts.

Brace yourself because we are about to enter the best months of the year for the stock market. This seasonality pattern is most commonly called the “Halloween indicator” and lasts from November to April - where most of the returns have tended to originate historically.

But this year was atypical in that we had a spectacular rally early in the year. In fact, this was arguably the most hated rally since very few purportedly believed in it or predicted it. And yet it happened. In any case, seasonality patterns should not be confused with blueprints. They are merely loose fitting guides to be draped over price action. The stock market certainly does not heed them every cycle.

According to Mary Ann Bartels, a technical analyst ranked second by Institutional Investor magazine, the weakness we should have seen may simply be delayed, rather than skipped outright. Here is a chart comparing the S&P 500 so far this year, compared with the other instances where seasonality was turned upside down:

Source: Bloomberg

While Bartels is looking forward to a correction to end the year, she does expect that to set up a base for further gains next year. She expects the S&P 500 to reach 1325, a further 22% rise from here.

Diligent readers will recall a historical study provided by guest writer, Wayne Whaley where 7 consecutive months of positive return have a surprisingly bullish bias going forward. October isn’t over obviously but with a 3.21% return (so far) we are set for a continuation of the short term strength that defies the intuitive expectation of ‘mean reversion’ after so many positive months.

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.

I’ve been meaning to write a review of Jason Goepfert’s website, SentimenTrader, for a while now. I’ve used them myself and referred to their analysis before. If you’re unfamiliar with it, SentimenTrader is basically a one stop shop for actionable technical analysis. The name of the site is a bit misleading since it goes above and beyond simple sentiment measures and keeps track of a dizzying array of indicators and data. If you’re really into technical analysis, SentimenTrader is your wet dream.

Goepfert has been a trader for around 10 years and before worked in the operations department of a large hedge fund. But his credibility as a technical analyst was cemented when he was awarded the 2004 Charles H. Dow award for his analysis of mutual funds cash reserves(pdf) as an indicator of market performance.

What attracted me to SentimenTrader was their focus on actionable analysis rather than just research for research’s sake. You can find a lot of insightful commentary nowadays from various good sources. But almost none of it is really going to help you make money as a trader. That’s what sets SentimenTrader apart. No matter what your style of trading, it is helpful to have a guide that can give you a better understanding of the trend and point to areas where it has a high probability of changing.

The other reason why I like Jason’s site is that he is an inexhaustible fountain of ideas. Sometimes it seems he has one a day! Anyway, he methodically researches every single one and if it survives scrutiny, shares it on the site. I suppose that’s how he has come up with his numerous proprietary indicators. Unlike many though, he doesn’t just blindly follow an indicator but instead picks it apart to get to the underlying concept. And he is ruthless in discarding indicators when he notices that they stop working.

To see some specific examples of what I mean, check out Goepfert’s contributions to Minyanville. Or register for a risk-free 2 week trial.

The only criticism that I can offer him would be to improve the design and user friendliness of his site. The look of the site simply doesn’t match the caliber of information it contains and it may turn away some who ‘judge a book by its cover’.

Very soon (hopefully tomorrow) I’ll have a special announcement related to SentimenTrader which you won’t want to miss

Stan Weinstein is a veteran technical analyst and author. Unlike many other ‘gurus’ he only wrote one book: Secrets for Profiting in Bull and Bear Markets. He’s been badgered since its publication in the 1980’s to write more but he always counters with ‘I’ve already said everything I could have said’. Which is very true. Take one novice, mix liberally with the Weinsteinian market approach and you’ve got yourself a trader who can go long and short, identify market tops and bottoms and manage their risk intelligently.

Since he wrote his classic book, Weinstein went on to author a retail newsletter called the ‘Professional Tape Reader’. He has since discontinued it and now Weinstein dedicates his considerable expertise and experience to publish an institutional service called the ‘Global Trend Alert’ (here’s a sample from 2005 (PDF)). Only problem is that it goes for $40,000 a year!

So, what to do if you aren’t a hedge fund and can’t soft-dollar it? or if you just don’t have $40K between the couch cushions? Well, for one, start by reading his book. Everything he does in the Global Trend Alert comes directly from the analysis he outlines there. Second, tune in to the Nightly Business Report on PBS. Weinstein is a guest on the Market Monitor segment of the show. Unfortunately, the rotation of guests on that segment is so you get to hear Stan’s take on the market only a few times a year. Read the transcript of his latest appearance in November 2006. Third, start analysing the market using the same tools. And go back and compare your understanding with his previous interviews in the archives.

OK so there isn’t exactly a way for you to get the $40,000 Global Trend Alert advisory service for free… but when you internalize Weinstein’s approach, you actually will have gained much more. You’ll be able to truly understand the why and how rather than having the end-product served up to you on a silver platter.