Inflection Point Modeling

One comment that I have recently read a lot is that "Market is very resilient," and a common question that any market savvy person should ask is "Are we approaching a trend reversal?" In any case, both statements are very thought provoking, and I have been thinking about these two notions i.e. market's resilience and trend reversal, for the last few weeks. 

While I was thinking about these statements, I got myself involved in a neat little programming project. During this project I came across a unique method of analyzing the stock market's internal harmonics. This method might be useful in analyzing crucial trend reversals in conjunction with my favorite Market Matrix (which I will discuss over the weekend).

I have analyzed this model over various time-frames and have found it to be a good indicative tool. However, there is always room for improvement and I will try to do so on a regular basis. In any case, since modeling can never substitute real time analysis, observations and implementation, I am publishing the latest chart of this model. It shows SP500 along with various trend reversal signals generated by this model during the last 2 years.

Trend Analysis Model

Each of the two graph employs a different model for calculation and graphical purposes. It is evident from the plot that these models have generated several reversal signals, and almost all of them have corresponded to a short-term top or bottom. Thus, a natural question to ask would be that when is the next reversal date?

The next reversal date (according to the model) is highlighted in the plot. It comes out to be January 6, 2010 (+ or - 3 days). Now the question is, whether it will be a top or a bottom. The answer will depend on whether we drop into this reversal time window and then bottom out, or do we continue to rise into this reversal time window and then top out.

In short, right now these plots are suggesting that a significant trend reversal could occur within one week. This reversal can be significant because the reversal potential is present in both of these models. When viewing this trend-reversal date in conjunction with the current lopsided sentiment picture (extreme optimism) and completed wave structure, there is a very high possibility that we are approaching a high rather than a low and that this high can produce a significant decline.

Note: 

1 -If the market did not decline or rise at one of these trend reversal points, then it went sideways for some time. It normally happened in strong up or down trends.

2- Always trade in the direction of the trend. Even if there is a trend reversal date, wait for confirmation by other signals because: 

“The market can remain irrational longer than you can remain solvent.” - John Maynard Keynes

Break till December 18, 2010!!!

In financial markets there are times when one needs to be aggressive and other times, when one should allow the market to show its path. We are currently at one of these junctures, where my Market Analysis Matrix is painted like a rainbow. Therefore, I have decided to take this opportunity to observe the first 10 days of Muharram and to study for exams.

With contrasting signals abound, this is a very interesting time for the stock market. Market trend at all time frames is up, but the sentiment is pretty bullish indicating a decline. This confusion is amplified by unclear pattern of the recent, not so strong, rally, coupled with near-term cycles turn dates. Therefore, one should allow the market either to pull back or to start a strong rally, before jumping in.

Regular blog updates will continue after December 18, 2010.

In the mean time, if I do get some time and see some interesting development, I will write a quick post.

Note: Always trade alongside the major trend of the market. Mean reversion is a common aspect of different markets and also life i.e. anything which goes up must come down. But coming down does not mean a new bear market nor does it mean a personal life crisis. It is just a pause before we climb the next few stairs in our quest to destination.

In this regard, the most important question is, "How to differentiate between a 'Mean Reversion' and a new 'Bear Market'"?

Thank you for showing your continued interest in this blog. If you want to be added to my weekly mailing list, please leave your e-mail address in the comment section or e-mail me at: subscription.ust@gmail.com

Stock Market, Trend Alignment and Indicators

As I was going to write about today's market action, I came across an unfinished post from Sunday - November 28, 2010. It seems like now is the best time for this post.

It was initially being written in response to an article published by Zero Hedge titled, "Smart Money Preparing For Sell Off Like Never Before." Please visit the following link for the original article at Zero Hedge.

The above mentioned article provided an interesting analysis of the recent anomalous stock market activity of the 'Company Insiders' and of the 'Smart Money People.' However, this behavior in itself did not guarantee a crash nor precluded a significant rise. This statement has been proven right by the strong rally of the last two days. On Sunday, in response to Zero Hedge's article, I wanted to stress the fact that these observations were just data points and not guarantees.

Financial markets are inherently intelligent and continuously evolving entities, and therefore, they should be followed rather than dictated. In order to trade successfully, one should align himself with the major market trend. In this regard, one should treat various key indicator based developments only as indicators rather than future predictors. However, if a development is extremely significant then one should trade with strong risk-management discipline.

One of the primary goals of "Understand, Survive and Thrive," was to present a broader overview of the stock market internals and to analyze these markets via the Market Analysis Matrix (used for weekly stock market review). This matrix is based on the below mentioned trading lessons, optimized for their respective significance.

Trading Matrix

This matrix shows the relative importance of each individual trading/investing component. If one follows these segments in a systematic manner, hopefully he will not only be aligned with the major trend but will also be successful in the financial markets.

I will continue to use my trading algorithm to continuously optimize this matrix and the corresponding Market Analysis Matrix. I will continue to update this blog with the latest state of this Matrix. In one of the future posts, I will further elaborate on this chart.

Stock Market Analysis - Nov 28, 2010

Recap

Last week's analysis suggested that the market might bottom during the Thanksgiving week. Over the last week, market has gone sideways to down - tracing out a triangle or 1-2 formation. Triangles are normally followed by a final burst in the preceding direction.

Stock Market Analysis

Based on recent sentiment readings, historical perspective, indicator's analysis and Elliott Wave structure, it seems like market is tracing out a series of first and second waves before a significant decline in third wave. Detailed analysis is given below.

Market Matrix:

This Matrix gives a pictorial representation of the internal market strength, indicators and suggested turns. Based on the current picture, we have many neutral to bearish signal, as evident from Red and Yellow colors. These color codes are based on my historical analysis and market scores. This Matrix is used to come up with market related trading conclusions.

This market behavior resembles the stock market behavior of February 2010, but in reverse direction. In February 2010, market bottomed and then went sideways (traced out a triangle) before launching a two month rally. A significant development at that point was that as the market moved sideways, sentiment declined sharply. This decline in optimism indicated market's trend reversal, as market shook loose a lot of bulls before a strong rally. Similarly right now, market's sideways movement has resulted in a noticeable increase in optimism. This might mean that market's trend has already reversed and market is just shaking loose as many bears as possible before the decline. As per "History Does Not Repeat Itself...!! or Does IT?" history will only repeat when very few people are expecting and presently very few people are expecting above mentioned similarity.

Conclusion

There are certain cycles bottoming in mid December. Above analysis points out to the possibility that this market might be getting ready for a decline into the middle of next month, followed by the end of rally (Santa Claus Rally).

High Probability: Decline into a low next week or further continue the decline. Nature of decline will govern the nature of low (long term low or short-term low)

Low Probability: 1- Rise to a new high before decline. 2- Very shallow decline and then make a new high

Risk Management: Keep stop above high (in case market decides to turn up) or keep stops above downtrend proprietary Moving Average. 

"The best speech is one that is short and reasonable" - Hazrat Ali

Life through the Lens of Wall Street (Behavioral Finance)

As mentioned in "What is Understand, Survive and Thrive," one should utilize financial market's behavioral analysis to improve his daily decision making process and to better understand the concept of life. Although it is a very demanding journey, it is a journey worth taking.

Recent confusing stock market activity: inconclusive patterns and indecisive indicators (please refer to stock market analysis for Nov 20, 2010), very closely resembles our daily life. Every day we face various choices and make numerous decisions. Each decision is like a gamble, because alongside the possibility of being successful, it always entails the inherent risk of failure.  

The word "possibility" is the key over here because any and/or every decision can either backfire or be immensely successful. For example, a person who leaves his job to start his own business with the hope of making money, might either be very successful or might lose everything in life. In real life, out of multiple new ventures only a handful businessmen, like Steve Jobs and Bill Gates succeed.  On the other hand, thousands who are left behind, either lose their jobs, life-savings, family life or all of them. This point brings us across the concept of "Gambler's Ruin Problem" in probability theory, where a person might become infinitely rich, go broke or just walk randomly.

This fact of life forced many philosophers to come up with the notion of luck i.e. meeting the right person, at the right place, at the right time. In this regard, many successful investors might argue that luck favors the brave - a person who follows investing rules and manages risk. However, not every rule abiding trader thrives in the financial world, as it is rightly said on the Wall Street, "A trader is as good as his last trade."

In short, like investing, life is very complicated and needs careful analysis. Therefore in my opinion, one should always calculate risks associated with different life related decisions. Furthermore, after achieving success one should always be humble, ready to give back, share his knowledge and do not boast about his success. And one should always remember that no matter how successful he is, these successes can always prove to be fleeting. The rise and fall of Mr. Durrant, founder of General Motors or the great Steve Jobs - from being the father of Apple PC to being kicked out of his own company - are some of the best examples in this regard.

A great philosopher, sage and scholar - Hazrat Ali A.S. - once defined this world in the following words: 

"Be most wary and cautious of this vicious world at times when it allures and pleases you the most because it is an old trick of this world that when a man is most happy with pleasure of owning and possessing it, it suddenly deserts him and when a man is most confident of its protection, help and love, it certainly forsakes him."

When one analyzes this proverb in the broader scheme of the worldly life, it feels so true!!!

I will look forward to reading your replies and interaction on this interesting topic.

Stock Market Analysis - Nov 20, 2010

This week, I have decided to bring forward a unique, easy to understand, graphical and matrix based method of Financial Market's Analysis. This method is currently a work in progress. It will ultimately be used in conjunction with computational analysis techniques with pre-defined risks and profit objectives. I will try to explain this Market Matrix over the coming weeks.

Synopsis - Market Analysis

This pyramid combines four major aspects of stock market analysis and gives out the conclusion, based on detailed matrix analysis.

Financial Market's Pyramid

Market Matrix Analysis

This Matrix gives a pictorial representation of the internal market strength, indicators and suggested turns. Based on the current picture, we have many neutral to bearish signal, as evident from Red and Yellow colors. These color codes are based on my historical analysis and market scores. This Matrix is used to come up with the above mentioned conclusions.

Conclusion

Market is neutral to bearish. Although the wave structure is not clear, the kind of optimistic sentiment that we are seeing right now, does not suggest that we have seen the low for the correction. 

High Probability Scenario: Decline into a low next week or after Thanksgiving. Nature of decline will govern the nature of low (long term low or short-term low)

Low Probability Scenario: Rise to a new high before decline. Or instead of a larger decline, we only get a shallow decline and then make a new high

Risk Management: Keep stop above high (in case market decides to run up) or keep stops above downtrend proprietary Moving Average.

Quantitative Easing and Recent Market Behavior.... Perplexing!!!

Last week turned out to be a very eventful week, with numerous markets marking a turn on the weekly time frames. However, the most interesting development was amongst the US Dollar, Treasury bond yields and Stocks. The following figure is a visual elaboration of this interesting development:

Treasury Yield vs Stocks vs US Dollar

In short, we are witnessing a totally opposite market behavior than what was expected of Quantitative Easing. This behavior further highlights the fact that financial markets do not follow the obvious path, and presumed relationships can disappear at any time.

Quantitative Easing Background

Quantitative Easing strikes out as a logical technique to further reduce the yield of treasury bonds and to stimulate the economy, after having a near zero Federal Reserves' policy rate. In theory, quantitative easing could help in stimulating the economic activity. 

QE Proposed Cycle

QE should result in increased demand for treasury bonds, resulting in higher bond prices and lower yields. Lower yields will translate into lower mortgage rates, lower auto-loan rates and other decreased borrowing costs. These lower rates will encourage consumption by consumers and corporations. Therefore, stimulating the overall economy. Furthermore, alleviating the deflationary pressures by devaluing the US Dollar. Above all, all of these developments will prop up the stock market.

One interesting aspect to keep in mind is that bond yields can also go down because of fear trade, as what we saw in summer of this year i.e. more people coming out of stock market and entering the bond market. On the other hand, falling stock market prices can also send the yields soaring. For example, ill performing economy will cause the stock market to decline along with rising bond yields, like what happened with Greece, Ireland and Spain. Therefore, bond yields can either rise or fall along with declining stock prices based on investor's perceptions. 'Leveraged Financial Markets' by William Mawell is a very good read on this subject. 

Recent Market Behavior (April 2010 - November 2010)

During the Summer of 2010, the treasury bond yields were falling along with a declining stock market and rising US dollar. At that point, it was assumed that treasury bonds were a safety play in a tumultuous market. Moreover, there were worries about deflation with a rising US dollar. 

This perception changed in August 2010, when yields continued their down trend alongside a rising stock market and declining US Dollar. This directional change was attributed to the prospects of quantitative easing. But over the past week treasury bond yields and US Dollar have started rising sharply along with a declining stock market, which is contrary to the presumed implications of QE2, which was announced on November 3, 2010. 

Under these circumstances, are the treasury yields telling us that there is no fear associated with the recent stock market decline (which in itself is a contrary indicator), or are the investors more worried about the inflation i.e. increased interest rates in future? But if the US dollar is also rising then shouldn't one be more concerned with deflation rather than inflation? According to certain technical, Elliott Wave and sentiment based scenarios, US Dollar has started an epic upwards voyage. 

Conclusion

To summarize, this convoluted financial market behavior suggests that there is something significant brewing in the market place. Although, one week of reversed relationship does not mark a trend, one should closely analyze these developments and observe further economic indicators, to decipher future economic movement and to understand the true impact of Quantitative Easing. 

In one of the future articles, I will bring forward the bearish vs the bullish case for the treasury bonds. This will be a fascinating study because treasury yields have been in a persistent downtrend since 1980s, and are we near a bottom?  

Finance = Free Cars ??? ..

Stock Market Analysis - Nov 7, 2010

'Understand, Survive and Thrive' is determined to bring forward a novel stock market analysis technique based on behavioral finance and risk-judgement, coupled with socio-economics. In doing so, we will not go in the details of fundamental analysis, technical analysis, cycle theory, Elliott Waves and other financial evaluation techniques. Detailed analysis of these individual techniques are easily available on the internet. Our analysis is based on the combination of all of these techniques. 


MARKET ANALYSIS


Bull Case

Nasdaq (2007-2010): Inverted H&S

1. Massive liquidity injection => Inflated commodity and stock prices.
2. Enormous inverted Head and Shoulder pattern in Nasdaq, ranging from 2008 to 2010 => Bullish
3. A long term Elliott Wave* count (monthly time frame), suggesting upward move to around 3000
4. Stock market above proprietary moving averages on hourly, daily and weekly time frames. This is sign of a strong market 
5. Higher highs and Lower lows. This shows upward trend
6. Continuous money out-flows from stock Mutual Funds. I do not know how to conclusively read into this data, other than there is some what pessimism.

Bear Case

1. Uncanny similarity between today's stock market and that of 2007. 
2. Extremely Optimistic Sentiment: Some sentiment indicators are exhibiting all time optimistic extremes, while others are showing bearish divergences (Higher high in indices, while lower highs in sentiment measures). Put/Call ratios are also showing optimism.
3. A near term Elliott Wave* count (daily time frame), suggests that market is near a top: This can turn out to be a more important top, if the market decline but bulls remain stubbornly optimistic.
4. With the recent stock market strength, there is a possibility of false breakout: Bull Trap
5. Financials have recently rallied after consolidating for weeks in a triangular shape. Post triangle rallies are usually last spikes. Therefore, rally in the financial stocks might soon get exhausted.
6. Corporate insiders' Sell to Buy ratio is extremely high. This is a typical bearish signal.
7. Seeing David Tepper and Bill Miller on national television, proclaiming the start of a multi-year bull market,  from a contrarion's perspective can correlate to a stock market top but to a bottom. 
8. US Dollar might have bottomed: Elliott Wave count appears to be complete; Dollar just experienced a post-triangle spike, which is normally the final thrust; Extreme pessimism towards US Dollar i.e. only 5% bulls in DSI; Widespread perception of dollar devaluation is also another contrary indicator.
9. Certain cyclical tops in the near term
10. Not very good internal breadth measures 

CONCLUSION


This is a strong market and has been moving up for some time now. However, in doing so it has convinced a lot of people to join the 'Bull Club', which is not a very healthy sign. Now the question is, is this bull strong enough to continue marching higher by dismissing all of the above mentioned bearish observations and technical divergences? 
     To summarize, there are many danger signs but one should not fight the trend. One should keep stops in place, be vigilant for any reversals and analyze the nature, internals, sentiment and wave structure associated with these reversals. This analysis will tell us that if the stock market is going to go much higher or if it is going to trap thousands of bulls and roll over.   


*  These Elliott Wave counts meet all the conditions and are not currently widely used. Therefore they have higher probability of being correct.

History Does Not Repeat Itself...!! or Does IT?

1930: Markets declined after counter trend rally

2010: Markets continued to rally after a brief pullback

Astonishing similarity between the stock market patterns of the Great Depression (1929-1930) and the Great Recession (2007-2010), bring to mind the famous adage, "History Repeats Itself." However, it seems like if a person would have followed the history he would have lost big time, because history stopped repeating without any notice.


As we might all remember that not long ago, hundreds of financial pundits were talking about a 1932-like crash purely based or charts, waves, cycles and myriad of other reasons. Alas! these advisors picked up this similarity at a point when it went away. And if they had not adjusted their analysis with the market, they would have lost a lot of money. 


In short, market is a continuously evolving intelligent entity, which likes to deceive the majority especially historians. Therefore, as long as there are too many rigid market historians, "History will not repeat." On the flip side, history will be repeated when historians are not looking for the repeat. Thus, it is quite possible that this recent surge is just a fake-out (taking out a lot of stops), before the repeat of 1930 - A trader should always be prepared.


Life Lesson: 
One should learn from his past mistakes and try to be prepared for similar adverse situation in the future. However, history will not repeat when one is prepared, but rather when one is not. 

Last Quarter of 2010 - (What is U, S & T? - Part 3)

During the last quarter of 2010 (next few months), I will address the following topics at this website. These posts will be intriguingly short, uncannily thought provoking and direction oriented. Furthermore, I will always be open to suggestions and comments. These comments will help me learn more, refine my financial perspective and update analytical conclusions based on reader's comments.

Featured Discussion
Stock Market: The Intelligent Evolution

1. Introduction
2. Intelligent Being
3. Investor psychology
4. Socio-economic perspective
5. Making money: quantitative strategies
6. Statistical significance of market: Long run probability of success (t -> ∞)
7. Financial Analysis Techniques - categorization (Justify or Debunk)
• Fundamental Analysis
• Technical Analysis
• Cycle Theory Analysis
• Quantitative Trading
• Elliott Wave
8. Conclusion and Interaction

Goal:             Indentify the short-comings and the advantages of various financial analysis techniques. Try to combine these techniques based on their individual attributes.

Note:            Although I could have used the featured discussion section to discuss the stock market and different investment possibilities, I would rather use this opportunity to explore and understand the core of financial markets i.e. their mechanisms, behavioral significance  and analytical techniques.

Additional
- About Me ( 2 parts)

- Stock Market Analysis  

- Surprising real world observations & stats  

What is Understand, Survive and Thrive? - Part 2

"Understand, Survive and Thrive" will explore the field of finance from a unique perspective. It will fuse multiple financial analysis techniques ranging from Cycle theory to Elliott Waves, and from Fundamental analysis to Technical methodologies, to decipher erratic stock market behaviors. Since stock market gyrations have wide ranging global policy impact, it is imperative to learn about their causes apart from what is stated by the media.

In this journey, engineering psychology - creativity and ingenuity - will be our most active companion. It will be used to justify, debunk or combine different financial analysis techniques. Alongside such stimulating discussions, I will try to bring forward global stock market analysis. This analysis will be based on the combination of above mentioned techniques, as implemented by various stock market gurus. 

Furthermore, this blog will leverage the human behavioral aspect of stock market, to narrate and analyze real-world experiences. These experiences will enlighten the readers about broader impact of our everyday decisions on the social and investment realm.   

In short, the goal of this blog will be to address current financial markets and to increase awareness about the importance of engineering based creative financial analysis. In Part 3, I will discuss the timings of these posts and proposed content for the next month. 

What is Understand, Survive & Thrive? - Part 1

Engineering is a very unique field. It encourage analytical reasoning, fosters conspicuous contemplation,  and  promotes creative designs. This combination leads an individual to think about various aspects of life, job, investments and above all the notion of success, in a very different way. While I was an undergraduate, I started experiencing these engineering induced changes in my personality.


Over the last 3 years, I have experienced a logical evolution of my personality. This evolution was accelerated by the economically problematic and self-enlightening year of 2008. As a result of these events, I started studying economics, finance, financial mathematics, socio-economics, human psychology, modern cultures and overall analysis of global events. Throughout this analysis, I have tried to relate my findings with real life experiences.

Therefore, in "Understand, Survive and Thrive", I would like to capture and share this continuously evolving analysis of life, economics and sociology. The theme of this blog will be to understand some of the realities of our world from a socio-economic perspective and how can one use this perspective to benefit his/her life.  

In the 2nd Part of "What is Understand, Survive and Thrive," I will further discuss some of the topics that will be discussed on this website.

The Week Before November 2010

It is not only interesting to see the financial world in a state of euphoria based on possibility of QE2, it is also very intriguing to witness the changes in the American political scenario. Since I started analyzing financial markets, three years ago, I have been amazed by their similarity to the human psychology. Humans inherently abhor uncertainty and try to minimize it as much as possible. And for this very reason several corporations have risk-management units who try to actively mitigate risk. Although at surface this makes sense, this risk-management or "the fear of the unknown" can also result in irrational, untimely and hasty decisions, which can prove to be catastrophic.

A similar situation is being faced by the US Fed today. In order to stimulate the economy they pumped trillions of dollars in the US economy. However, the overall monetary based shrunk instead of increasing. This is classic example of an underlying deflationary economic current. Now Fed is on the verge of a second round of Quantitative Easing. I personally think that this is a decision, which if not work, can have catastrophic impact on the US economy and the global socio-political environment.