Sunday, December 02, 2007

Timing the market

MARKET READER: Timing the market

BY: Den Somera

The market has been very difficult and frustrating. Everything seems to go wrong. No amount of effort to correct the situation seems to work. The more you try, the more it gets awry.

It's funny that in times like these in stock trading, I find myself drifting in wishful thinking like a little boy.

How I wished I can be like the biblical character Joseph the dreamer. He had the talent to interpret dreams and could see into the future.

Because of that, he became rich and most revered. He became the second most powerful person in Egypt, after the Pharaoh, because of his talent.

Fortunately, the memory of my horrible beginnings in stock trading is always there to dissuade me from indulging in such foolish fascinations.

It will do me better to consider the voluminous literature on market timing techniques that are supposed to let you beat the market.

What are these techniques for timing the market? Are they real? Do they really work? Can ordinary mortals like you and I understand it? Can they accurately forecast market prices? Better still, can they show critical turns that give specific buy or sell signals? Again, are they consistent?

Of the many models used to time the market, there are four conceptual platforms where they can be categorized. These are the study of price trends or directions, price cycles or oscillations, the natural law on the order of things in the market, and approximating market sentiment through neural networks.

The charting of price trends is the most popular. It consists of plotting price changes and volume fluctuations. The patterns or formations created are taken to reveal future price trends or directions.

So, we have for example what is called "head and shoulder" patterns represented by the letters M and W, where the former indicates a price downtrend while the latter signals a price uptrend.

There are also wedges, flags and pennant, chart formations of prices that reflect other price pattern concepts that may signal the state of price trends.

Among the popular models applied in trend analysis are the Dow theory, Elliott theory, and moving averages and their auxiliary models.

But these indicators are methods that are only helpful in identifying trends. They can only indicate when a trend has generally changed. That means it could be too late to know.

At that time, there were those unsatisfied with what trend analysis could do. The various trend-following models are short of being timely.

This gave rise to the use of oscillators and price cycle theories, including the study of the underlying principles or structure (whatever that is) that give order to the universe.

Oscillators are considered by many to be more superior as a market timing device. They claim it does not only help find trends; it can identify turning points critical to generating specific buy or sell signals that will help traders better time the market.

Thus, we have the most admired price momentum or rate of change theory and their variations like the stochastic and relative strength index.

These methods are devices that measure the pulse of the market, or state of market psychology. They interpret market sentiments and their inclinations.

They focus on finding price turning points such as overbought or oversold situations and price divergence points. Most regard them as reliable instruments of timing the market.

All these models, however, are said to be retrospective. They are more accurate on hindsight. They are not anticipatory.

One such device that holds promise is neural networks. It is the use of artificial intelligence to predict prices.

Neural networks can identify trends and changes in the direction of stock prices as they are happening, and not after the fact as in the case of the previously mentioned forecasting models.

The only problem is that it is the technology rather than the concept that approximates market psychology or sentiments. The neural network is just artificial intelligence that can be trained to make predictions. But they can only be as good as what you feed them.

Indeed, all forecasting models in use today are empirical tools. They are founded on a posteriori methods that are based on observed facts. Decisions are based on forecasts and analyses using past data such as prices, volume and value of transactions.

But even with this very latent weakness, existing forecasting models remain to be of practical value. They are a faithful bearer of the past that somehow is useful for investors to make valuable trading decisions. Most of these are valid.

On that basis, we will now shift our attention to the review of various technical analysis models currently in use. We will now leave the review of fundamental analysis and its different approaches, which we did at the start of the year.

Familiarity of technical analysis has its practical value in stock trading. So, hang on. Join me in reviewing the different models of technical analysis until the end of the year.

(The article has been prepared for general circulation to the reading public and must not be construed as an offer to buy or sell any securities or financial instruments referred here or otherwise. Moreover, the public should be aware that the writer or any investing parties mentioned in the column may have a conflict of interest that can affect the objectivity of their reported investment activity. You may reach the Market Reader at

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