Miss Cleo: Technical Analysis 101
Technical analysis, like any strategy that largely dismisses economic fundamentals, will always be controversial. Technicians execute trades according to nominal price action, market sentiment, and human psychology, instead of corporate profits.
To the uninitiated, technical soothsayers have much more in common with late night Miss Cleo infomercials than they do with any serious securities analyst.
Asset Prices and Volume
Technical analysis strictly relates to asset price and volume data taken directly from the stock ticker – to identify trends and patterns.
Volume describes the number of securities that change hands through a particular transaction or set time frame. Technicians highlight abnormally large volume as further confirmation of their respective investment theses.
The Trend is Your Friend
Technical analysts monitor charts and volume to identify investment trends. The “trend is your friend” cliché suggests that immediate price action is likely to continue into the near future.
Expect for this school of technicians to buy through bullish trends and sell out amid bearish market weakness. Yes, momentum trading takes the “buy low, sell high” strategy upside-down and drops it directly onto its head.
Support levels and resistance bands are all-important for bracketing price action and foreshadowing trends. After the ’00 – ‘02 dot-com bust, Microsoft stock largely languished in a tight range, between $25 and $30 per share, for more than one decade. Here, technicians would have repeatedly bought and sold Microsoft stock at $25 and $30 to turn quick profits.
By 2012, Microsoft stock had finally broken out of and blown through the $30 barrier. Twelve years later, in 2024, Microsoft had put in a thirteen-fold increase and was approaching $400 per share. Microsoft dispatched Apple earlier this year as the most valuable business in the world, with $3 trillion in market capitalization.
Market Price Trend Reversals
A skilled technician must identify market price reversals, or inflection points where the trend shifts from bullish to bearish and then back again. Traders might also install options strategies to lock in profits or even double down upon a position.
Head-and-shoulders and double-tops are classic technical reversal patterns. As their names would reply, these formations turn bearish on the chart, after prices repeatedly approach the neckline upper resistance point, only to weaken significantly. Alternatively, reverse head and shoulders and double bottoms might mark bearish to bullish transitions.
Onyx Investments is particularly weary of the dead cat bounce. Stock market crashes are rarely one sudden, elevator ride down. In retrospect, a stock market crash is often the result of a series of events and abnormal volatility, which may unwind over the course of several days or even weeks.
The dead cat bounce begins with a sharp and sustained drop. Sentiment is decidedly bearish, before unwitting bargain hunters emerge at the assumed bottom.
Here, any buying activity draws in more cash sitting on the sidelines and a furious, two-day rally ensues. Short-term traders would then exit out of their positions for a quick profit and leave retail savers holding the bag, right before the market collapses further to even lower lows.
Remember, the COVID-19 crash took one full month, before stocks established a real bottom, on March 20, 2020. From there, the stock market did not recover pandemic losses for another eight months, after The Fed and Treasury officials flooded the financial system with liquidity. Unfortunately for savers, it is this very same cheap money that ignited double-digit inflation and $18 Big Mac meals at McDonald’s.
Financial Risks and Strategy
Onyx Investments will not even pretend to place short-term bets and market prognostications. Ironically, technical analysts rely upon patterns to make trading decisions, without fully realizing that the human mind is built to see patterns, in everything.
Technical analysis will be privy to many fits and starts when reading from the crystal ball. We do recognize that even a broken clock will be correct twice a day.
Still, over the long-term, financial markets have shown a remarkable ability to separate the winners from the losers. For this, we master fundamental analysis to value real profitability, before buying and holding stock over the long-term.
Small, retail investors are best served to dollar-cost-average. Dollar-cost-averaging mitigates financial risks by having savers invest smaller amounts at regular intervals, rather commit to one large, lump sum investment.
Trading strategies quickly become obsolete when we all read and react to the very same things. Historians blame program trading for Black Monday 1987. On that date, the stock market crashed by 23%, when all of the super-computer algorithms agreed to sell now and ask questions later.