Battle of the Charts - John Rothe | Portfolio Manager, Quant, Tech Geek, And Sometime Superhero To My Kids

Battle of the Charts

(photo courtesy: Konrach)

The US stock market has a looming battle ahead. In one corner is the 100-year market trend. In the other, the famous analog chart.

Many traders and analysts have been focusing on the “100-year trend” in the market. They believe that the worst is over for us — that the government’s numerous stimulus programs have worked and the economy (and therefore the stock market) will continue to get stronger. The idea is that major investors, traders, and trading systems will recoginze the long-term trend line as the “floor” for the US stock market. This floor should be a major entry point for investors. If this floor or trend is broken, it signals that investors have lost faith in the markets. In fact, lost so much faith that they believe the market cycle we are currently in is worse than the Great Depression, which never violated the long-term trend.

On the other side of the argument is the famous analog chart. This chart compares the current bear market cycle with past bear markets. Market historians and traders love these kinds of charts. The concept is that the stock market’s trends are largely based on human emotion — mainly fear and greed. Because of this, many  believe market cycles repeat since investors fear the market under certain circumstances and get too greedy under others. An example of this is the Roaring 1920’s vs the Tech Boom of the late 1990’s. Both market cycles ignored the fundamentals of the economy and stock values and let the markets rise to unrealistic values.

In practice, past markets in analog charts do not line up 100 percent, but the correlation is still impressive. If you have been fortunate enough to see the movie Trader with legendary hedge fund manager Paul Tudor Jones, you would have seen how Mr. Jones actively used these correlations on a daily basis and used them to predict the 1987 market crash.

Which chart do I see as a better indicator for future market performance? I don’t like to forecast too far into the future on long-term market trends (and my all-seeing crystal ball is in the shop), however I have always been rather impressed with the high correlation of historical market analogs. It is no wonder they are a favorite tool of many successful hedge fund managers, and an important part of our daily market analyses.


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