Deep Thinking About Bias and a Very Long Term Analysis

I want to try to make a point in today’s post that could be life-changing for some traders once they finally start to ‘get it’.

Although I may be preaching to the choir to many of my readers…especially the grizzled professionals who make their living trading the markets–there are many out there (most, actually) who really need to consider what I am about to post very carefully. Once you ‘get’ the following concept, you likely won’t trade the same way in the future, and you may even be compelled to reconsider the company you keep and the advice you heed.

Although some might laugh out loud when they read this, I was actually the consummate ‘permabear’ at one time–and so I really ‘get it’ when I talk about the dangers of developing an internal bias.  An epiphany came to me after the NASDAQ crash in March of 2000 to October of 2002. In those days, I specialized in tech stocks and ETF’s, primarily the QQQ.

To get a grip on what was really happening with the real-world trading dynamics, which seemed to contradict everything I read and heard–I started with the theoretical premise that I could be beamed back in time with a detailed stock chart from the future –and that with that information I could make ‘perfect trades’ by going short at exact peaks and reversing to long at the exact bottoms. I created a program that simulated those ‘perfect’ trades and was absolutely astonished to learn that although the QQQ’s fell from a high of 120.50 to a low of 19.76 that the ‘perfect’ bulls actually made about the same amount of money as the ‘perfect’ bears!  How can that be?

The secret lies in the following simple illustration…

1) Two traders; one can only trade long and the other can only trade short
2) Each has $100 to invest
3) A mythical ‘channeling stock’ trades from $100 down to $50 and then back to $100

The first to take a turn is the bear. He shorts one share of stock at $100 top and then perfectly covers at $50

The second to take a turn is the bull who invests his $100 at the dip bottom and rides it back up to $100

At first glance you instinctively think, so what–they both made $50, right?  Wrong…

The bear made $50 or a 50% return on investment in a single share of $100 stock. Pretty good.

The bull, on the other hand, was able to buy two shares of the diminished stock at $50/share and he made 2 X $50 per share in profit. That is a $100 or a 100% return on investment for the same $50 swing!

Let that sink in and reread it as many times as it takes to ‘get it’.

I have posted the above example before, but sometimes it is better to look at a real-life scenario playing out in real-time, and so I have posted the following monthly chart of the ES to make the exact same point–but using an instrument that is less abstract…

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Okay, at first glance one thing is perfectly clear… on a monthly continuous chart the ES is showing a textbook example of a very long term bear market.   All those permabears out there are technically ‘right’ when they point out that very obvious lower high/lower low pattern–and I agree completely.

I have pointed out five data points at VLT (very long term) pivot highs and lows:

1) 1721.25 (March 2000 all-time high)
2) 830.75 (October 2002 ‘crash’ low)
3) 1545 (October 2007 recovery high)
4) 608.75 (March 2009 ‘crash’ low)
5) 1356.50 (May 2011 ‘Bin Laden’ high–not confirmed as VLT top, but the most recent top spotter high)

Okay, so lets use those datapoints to test the bull versus bear theory…

1) Bear leg number one: 1721.25 – 830.75 = 890.50 points
2) Bull leg number one: 1545 – 830.75 = 714.25 points
3) Bear leg number two: 1545 – 608.75 = 936.25 points
4) Bull leg number two: 1356.50 – 608.75 = 747.75 points

Total Bears = 1,826 points
Total for Bulls = 1,462 points

It’s definitely a VLT bear market.

Now, let’s work some real world returns expressed as percentages of invested equity (what really matters for investors)…

1) Bear leg number one: -51.7%
2) Bull leg number one: +86%
3) Bear leg number two: -60.6%
4) Bull leg number two: +122.8%

Total percentage gain for Bears: 112.3%
Total percentage gain for Bulls: 208.8%

Whoa! ..and those comparative returns are in a ‘bear market’!

There is a powerful message in this post above that some of you really need to hear. Consider it my Christmas present to you if you can let it sink in and modify your trading habits to insulate you from the propaganda and fear mongering that is so prevalent in our society and whipped into a frenzied state by the negative nellies (the majority of the herd) out there.

The smart bulls almost always win, even when the markets lose…and that is why the markets and the pros who control them will always be biased to trading the long side over time and why it seems, from a bearish perspective that everyone is out to get you (they really are).  It is all about greed and fear, and though fear is a powerful inhibitor and is used to freeze the players–greed is a far more powerful motivator for those who are in control.  The most money you can possibly make in a bear market is a 100% gain–and only if the company goes bankrupt.  In a bull market, returns on equity are unlimited.  An old adage is that bears don’t live on Park Avenue –and for those who understand the example illustrated above, it starts to make perfect sense.

Stops and Targets is set up to work the percentages on both sides in both bull and bear markets– and the algorithm definitely ‘gets it’ when it comes to setting up the probabilities.  It is all about risk management and returns expressed as a percentage of equity.

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On the chart above, you can see further evidence of the present balance over the very long term. The current price is sitting just above the middle of the very long term bullish trident and the two long term trend channels within that VLT trident show the triangle consolidation I have been pointing out.  Both of those channels have validity until one is broken, and the market is presently caught in a tractor beam at the midpoint of the VLT bullish trident.

Now, I have been called many things over the years, but one thing I have not been (accurately) called is wrong when it comes to an unbiased analysis over time.  I almost always detect the major turns within a day or two and never let my analysis be affected by the current ‘news and noise’.  I ultimately end up offending permas on both sides when I don’t say what they want to hear (at turns and after a reversal into a squeeze typically)–but the markets abruptly go up and down and a trader needs to see it as a cyclical process and to adapt one’s trading style to what the market will give.  At the same time, one needs to understand that it almost never ‘feels right’ to ‘be right’ in the market.  The pros go to great lengths to confuse traders to enhance their gains.  If, however, one understands the juxtaposition of greed and fear and how it sets up trades that favor a probabilistic outcome based upon the formulas expressed above, you likely will pay much less attention to the alarmists at the bottoms and the ‘sunshine pumpers’ at the tops and learn to trust what the instruments (Stops and Targets) are saying.

I likely won’t post much over the next week until/unless something major begins to occur (>1266 or <1195.50 for VST).  This market is probably coiling for a BIG move and when it comes… as always, we’ll be on it.

Merry Christmas everyone!

…my .02

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ES Update

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Looks like Stops and Targets’ IT resistance line at 1248.50 was the spot to take partial profits…

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That lines up favorably with the VST target at 1244 from yesterday’s chart.

Initial VST support is at 1225 and VST bulls are fine above the trend line breakout at 1212.75, which lines up favorably with Stops and Targets’ primary trend lines at 1214–and the VST bull/bear line at 1195.50

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The daily bar chart above does a pretty good job of showing the ‘big picture’ configuration.  Four timeframes are represented by shaded rectangles to show the compression of ranges within one another.  The smallest rectangle represents the VST and shows why I say that ‘VST bulls are fine above 1195.50’.  If that were to break down, the next major target for bears would be 1141.75.  On the other hand, if 1266 is taken out to the upside, that would trigger two time frames worth of stops and then target 1283.50 (IT range top) next.  Lots of pundits out there are getting worked up about things–but this market has been coiling in a tightening range since the October bottom spotter low at 1062.25 attained the IT target at 1283.50 (which has set up the current IT trading range).

The pattern since 1283.50 has been lower highs and lower lows–but time is the enemy of bears who have been looking for a continuation of the breakdown that started in May at the ‘Bin Laden high’ top spotter signal.

Nothing really important starts happening from a trending perspective until either 1266 or 1195.50 breaks…

…my .02

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ES Update

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Change in character…

After eight trading days following the VST trend line resistance lower (yesterday’s high was another direct hit on that trend line) we see a VST resistance breakout this morning.  Yesterday we got the stop run that often comes before a reversal move, and this morning is the fast move.

New bull/bear line is now at 1195.50 and that is the candidate for a new ST structural pivot that we will watch over the coming days.

…my .02

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ES Update

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The analysis remains the same as the previous post and the VST trend line is now at 1219.  (Friday’s high was an exact hit on that trend line)

…my .02

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ES Update

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Today is December Options Expiration…

VST trend line resistance continues to control the descent on a pullback from a 1266 touch of the IT trend line resistance at the top of the triangle.  Bears are fine under that line, but the most aggressive traders will start to cover once that trend line is breached.  As I type, the descending VST resistance is at 1225.

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Following are scaled daily charts showing the current big picture setup and one may wish to pay special attention to what started in April on the Commodities Index and the US Dollar…

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…my .02

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