How to Gain Your (Share) Market Advantage

Reddit

Australia get a new (old) Prime Minister next week? You have to imagine that Prime Minister Julia Gillard would desperately love to fire her petulant Foreign Minister Kevin Rudd. But then Rudd, in a fit of revenge, might resign from his seat representing Griffith in Queensland. Rudd’s resignation could bring the whole government down by destroying its one-vote majority in Parliament.

The soap opera drama over who will lead the Labor party is great entertainment. But does it mean anything for investors? Yes. You can imagine a scenario where a proper stoush for the party leadership and a snap election would be good for the share market. How?

An election would produce a result and vanquish one of the warring factions. Investors would get certainty on two issues hanging over their heads. First, we’d know if we’re actually going to have a mining tax. Second, we’d know whether the carbon tax will last the year.

All these public policy issues are “known unknowns”. That is, we know what we don’t know. That’s better than not knowing what we don’t know. But it’s not great. At times like this, we turn to the Wizard of Dawes, our technical analyst Murray Dawes, the editor of Slipstream Trader. Murray summarises his latest update like this:

Greece is a basket case even with the bail out so could still prove to be the black swan that brings the current rally to an end. But until then we have to respect the strong uptrend in the US market. The Aussie market is on the edge of breaking out above the key 4300 level. If it can do so I have targets to 4450-4600 but I would be a strong seller up there. The ASX 200 needs to fall below 4170-4200 from here for me to become bearish again.

You can watch Murray’s technical snapshot here. Long-time fans of Murray’s work know that he looks at key technical levels on the S&P 500 for clues about where the Aussie market is headed. The S&P 500 is bigger, badder, and more influential than the more famous Dow Jones Industrials.

While we’re on the subject, we may as well answer why we offer you the views of a technical analyst in the Daily Reckoning. It strikes some people as strange. It’s not so strange, though, once you understand where Murray’s coming from. He’s a firm believer in his own ignorance. That is, he starts from the position that the market is smarter than you.

That’s a nice, modest, starting place. There’s also something more interesting going on. Nine out of ten traders lose money. This suggests that all traders – or at least nine out of ten traders – are making the same mistake. What’s the mistake?

Murray’s theory of price action is based on the idea traders under stress tend to act emotionally. But traders are people too. And most people have brains that have worked in the same way, neuro-chemically speaking, for many thousands of years. Under great stress, confronted with several options, people almost always make the same decision.

Because people act emotionally under stress, and because they tend to make the same decision, this decision shows up in the price patterns of a chart as a trend. So, reading the chart becomes a study of what the nine losing traders are currently doing. If you can learn to trade against the nine losers, you can be the one winner.

We like this idea because it’s fundamentally contrarian. But is it right? Do people really tend to pursue the same course of action under stressful conditions? The brain certainly tells them to. In everyday life, doing what everyone else does is generally right, like driving down the same side of the street or eating at the best restaurant.

In trading, doing what everyone else does kills you. Once you know this, it’s almost like you know what people are going to do before they do it. You know how they think and act under stress. They don’t even know that they don’t know it!

If you have knowledge about human behaviour and price action that others don’t this gives you a huge advantage in the markets. You’re trading against a kind of pre-programmed emotional behaviour that shows up as a trend on a price chart. This has always been the premise of having a trading service as part of our portfolio of publications. You can judge Murray’s work yourself by watching his latest update.

Now, let’s get away from trading theory and back to the actual price action. As you may have seen, the Dow Jones Industrials went over 13,000 during US trading overnight. It’s the first time that’s happened since “the crisis” began. That probably means exactly nothing for Australia. The Dow and other US indexes are being pumped up by liquidity.

As our mate Greg Canavan wrote to us privately:

I think Australia’s poor relative market performance shows why other market rallies (US/Europe) are phony. The Reserve Bank of Australia is about the only hawkish central bank. Market gains here in Australia are therefore based on genuine economic growth and company performance…you get no free kick from loose monetary policy. Overseas, cheap liquidity is pulling the banking sector out of a hole and creating an illusion of prosperity.

That sounded right to us. But we thought you might like to see it rather than hear it. Take a look at the chart below. It shows the All Ordinaries are up 30% over the last three years. The chart uses the February 20th, 2009 closing price of 3353 and yesterday’s closing price of 4368.

$AORD

In the same time, though, the S&P 500 is up over 75%. That’s the gold line on the chart. The green line on the chart is XLF, the S&P financial sector fund. It’s up 108% in the last three years. You may recall that the Federal Reserve’s first round of Quantitative Easing (QE) ended in March 2009. That coincided with a market low and the current rally.

If Greg is right, then there will be a “great correction” in the phony markets this year. That’s exactly what he’s predicted in his latest report to prospective subscribers. You should read it if only to make sure you aren’t making the three investment blunders that could lose you money this year. Greg’s report is here.

Regards,

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
Reddit

Leave a Reply

Be the First to Comment!

Notify of
avatar
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au