Technical analysis is a very important part of my approach to the market. I have found it to be a very powerful tool but not everyone shares my enthusiasm for it. Typically these who don’t find it useful question its predictive value. They argue that the problem with technical analysis is that it attempts to use past performance to predict what will happen in the future. They argue that what happened yesterday has no bearing on what will happen tomorrow.

What they are missing is a very basic concept that is the foundation of technical analysis: as a stock moves up and down and people enjoy gains or suffer losses they will have an emotional reaction. People remember what they paid for a stock and have predictable emotional responses as a stock moves away from that point. If the technical analysis naysayers are correct then we would expect stocks that trade at their lows, where most holders have losses, to act essentially the same way as stocks that trade at their highs, where most people have gains. You need not look too hard to know that this generally is not the case.

Technical analysis is largely an exercise in psychology. It is an attempt to predict how people will feel and what they will do as their investments move away from their buy points. When someone starts a position, watches it sell-off sharply and then recovers, there is the inclination to want to sell the stock once it is back to breakeven. The idea of unloading this miserable stock that kept us awake at night is very appealing and therein lies the concept of resistance levels.

The biggest problem with technical analysis is that a lot of it is really bad and even nonsensical. Like psychology it is a bit of a soft science at times and applying a rigid set of rules is really more about money management than predictive action. The biggest mistake people make with TA is making it overly complex and being too rigid with its application. It is very important to draw a distinction between using TA for money management and using it for predicting stock movements. Arbitrary rules can work just fine for money management but are not good at predicting price movements. As long as people remember what they paid for a stock and have an emotional reaction to gains and losses then technical analysis will have validity.

Today’s market action solidified my recent thoughts of a post window dressing sell off. This of course occurred shortly after I was tempted to start reconsidering my thesis as the market looked strong in early trading.

We suspect lower oil and gas brought life to the market early but some hawkish comments from Fed Governor Fisher seems to have been the catalyst for the afternoon selling. A big intraday reversal like this is a major negative as it indicates the bulls don’t have enough powder to keep a move going.

Breadth was strong most of the day, but finished poorly with semiconductors and energy stocks doing most the damage. Also the increase in volume today is troubling.

Our posture is defensive at this point and we will continue to maintain that stance under the market tells us otherwise. A better day will come but for now we have to let the downside play out.  And wait for the damage to be repaired.  

Have a good evening

RevShark