Self-fulfilling prophesy?

Sometimes the market will stop at certain levels because players who believe in those levels will sell the market  as their specific indicators suggest a sell point. For example, moving averages are pretty much just lines drawn in the sand. They simply represent a rolling average price, and thus can indicate a trend – or a lack of trend. But players will sell a market (program trading does this automatically) simply because the moving average was cracked. Thus, the break of a moving average puts pressure on the market, and this creates a self-fulfilling prophesy.

 

Currently, the S&P 500 is toying with its 50 day SMA. In itself, that doesn’t mean much. However, the fact that may traders, and computerized trading programs, will recognize the 50 day SMA as a potential breaking point may influence the market to continue to pause. A break through the 50 day (it actually broke through on Friday, but I consider a break as 3 full days over the average) means that those “selling traders” are of less influence than the “buying traders”. Today and the next day or two will be telling of that potential.

 

Another self-fulfilling prophesy on the charts can be Fibonacci retracement targets. As you probably know, I place absolutely no faith in their value,  except in the fact that some traders and program trading applications might utilize them as sell targets. Here is a blog on my thoughts regarding Fib. Targets.

Currently, the S&P is toying with the 61.8% retracement point when measured from the recent peak, and subsequent trough of the recent correction. The above chart shows us both the 50 day SMA and the Fib retracements. Despite my hesitation to place any significance on these Fib. targets, it is a fact that some people do treat them with a an almost religious faith. As such, there may be cause for pause if the traders that do follow Fib numbers believe the current 61.8% retracement is significant. They will sell because the magic 61.8% number was hit.

 

All in, the next day or two will be telling as to who wins – the retail buying crowd who don’t know or care about such things as moving averages and Fibonacci targets – and those traders and computer programs who do. At the end of the day, the bulls will likely win, but there is cause for some potential sideways action or pullback. We’ll see how that plays out before the end of this week.

11 Comments

  • You have stated that no one indicator or moving average is enough and that all need confirmation of other indicators. I have found an indicator that works is a 20 day MA on the Chaiken Money Flow works (when the CMF crosses above or below the MA) but it is only a confirmation of other indicators and certainly prices.
    But the difficult part is that I have yet to find any formula that doesn’t results in simply too many whipsaws.

    Reply
    • Hi Fred–that’s where multiple indicators help–with the whipsaws. You look for multiple confirmation–but the indicatos must be looking at different things (eg trend, momentum, sentiment, etc)

      Reply
  • The monthly weekly and daily all saying different things if you look at their RSI and stochastically. What time frame is best to avoid over trading? My guess is the weekly.

    Reply
    • Yes, weekly charts are my starting points – especially for individual stocks and sector ETF’s. Markets can be looked at even longer termed (monthly, 20 yr plus data) for big trends and cycles. For the market, start at least at the weekly for 5+ years, look for the trend and formation, and at the big indicators like RSI and MACD mostly for divergences. Then go to daily and look at candlesticks, and at the factors noted my short termed system –stochastics, RSI, Bollinger bands for neartermed signals. My book Sideways covers all of this too if you haven’t read it.

      Reply
      • Dave–Forgot to mention–for market signals, adding non-price/volume stuff like sentiment, breadth and volatility can help–see my Bear-o-meter -On that thought-if you don’t have a copy, email me and I can send you the most recent CSTA Journal , in which my Bear-o-meter was featured (full explanation of the signals)[email protected]

        Reply
    • I knew what you meant. Try typing Fibonacci on your phone without a capital F some time. Fun with spellcheck!

      Reply
  • Hi Keith,

    I was watching Berman’s call last night on BNN and he mentioned that he follows the 21 day, 63 day and 252 day SMA which represents one month, one quarter and one year of trading days. I have not heard of published analysts using these numbers….if technical analysis is self fulfilling, is a person not best to hedge your bets on the most popular and most used SMA’s?

    Thanks

    Chris

    Reply
    • Christopher–to be clear, not all of TA is self fulfilling.The most important aspect of TA is support / resistance–and they rely more on past / previous buyers and sellers – yes, some self fulfilling side to the stopping points of resistance for example – but for the most part its really just the activity of old buyers or sellers who create supply demand at those levels. I recommend you read my book Sideways – it covers the reasons why certain indicators work. I feel its important to understand the logic behind them. That’s why I am a critic of Fibonacci targets–no logic.

      As far as the MA’s Larry describes, I would say that his system is best for trend following, But when it comes to what the crowd will do, I think you want to watch what the crowd is watching. And that’s the traditionally followed 10, 20, 50, 100, 200 day SMA’s. The most popular of those is the 200.
      Keep in mind, as I note in the blog – that a SMA is a point of possible stopping, but they can be overpowered by greater demand or supply forces.

      Reply
  • Hi Keith, had some bond money come up and decided to put the money to work trading VSP, simply selling when the 100 day MA is broken and buying back in when it turns back up, are there any other indicators you would suggest. Thanks Anthony

    Reply

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