Hey look at that. The S&P 500 is back over 1,000 after stocks in New York rallied on a Federal Reserve statement that the economy was “leveling out,” whatever that means. We left you in yesterday’s Daily Reckoning with a promise to discuss the dreaded ‘Fibonacci Retracement’ on the S&P that could portend a correction.
So let’s do that! And actually, it’s not inherently dreadful. Our Swarm trading technician Gabriel Andre uses the Fibonacci numbers to track trends in commodities, currencies, and stocks.
In fact, he’s been muttering to himself in French the last week that September may be a very good month for short sellers. He bases this on the Fibonacci numbers and the fact that futures traders are predicting a spike in the volatility index (VIX).
For the record, the S&P completed a 38.2% rally from its fall after the 2007 low. The Fibonacci numbers can be calculated for any two points. In this case, you take the high in October 2007 and the low in March and then graft the Fibonacci numbers on to the move. After a brief consultation this morning, we asked Gabriel if he could generate a chart showing the move.
Gabriel retreated to his Swarm lair and quickly conjured up the chart above. You can see the 38.2% level. And you can see that the index has rallied by 49% from the March closing low of 676l – which itself was actually a 12-year low. The rally left the index trading at about 18.6 times the aggregate earnings of the companies that make up the index. That valuation, according to Bloomberg, was the most expensive valuation since 2005.
Technicians – for better or worse – pay no heed to the fundamentals. With so much program trading on the indices (computers buying and selling shares based on pre-determined trading patterns) this makes technically driven systems somewhat self-fulfilling. Because everyone is using the same price triggers, the system generates the very movements it predicts.
“Yes indeed,” Gabriel added cryptically. “38.2% retracement level reached after the price action found some support on the 23.6% on July 10. A correction expected now. If it breaks above then the next target is 1,120 points, the 50% level.”
Though we find the language of the technicians largely incomprehensible, it seems to work for them; especially because on most days 50% of the trading on indices in New York is program trading. But it’s not New York we’re really interested in anyway. What we’re interested in is whether a market-neutral trading method can actually boost the returns of a buy-and-hold strategy on blue-chip stocks.
Gabriel has been back-testing a technical system on S&P ASX/200 stocks. We’re trying to see if there are certain large-cap stocks that trade in channels. It presumes that more active management of your large-cap portfolio is more profitable than a buy-and-hold strategy. That’s presumptuous, given that you rack up transactions and taxes every time you make a trade.
But so far, the results are intriguing. We’ll keep you posted. The motive for pursuing the system is that in a market with volatile money flows and undergirded with a constant level of uncertainty about earnings and the economy, you’re going to see a lot of big and hopefully tradeable moves in large stocks.
Mind you, it doesn’t look like these moves are the typical fast, one or two day moves you get in small cap stocks (the ones Gabriel tracks in the Swarm Trader). But what we’re seeing so far is that double-digit moves in large-caps are frequent and tradeable, if not entirely predictable. Stay tuned.
for The Daily Reckoning Australia