What a rally!
Last Friday saw some remarkable trading as the FTSE bounced back over 6000 and the Nikkei returned to pre-tsunami levels. After weeks of crushing uncertainty in the wake of a string of global crises, it suddenly seems like we are back on an even keel. How did that happen?
Well that’s the question I’d like to tackle today. Because this rally has very little to do with relief about the state of the world. In fact it has a great deal more to do with a powerful and very dangerous new force in the investment industry.
But here’s the good news – this short-term rally presents us with a great opportunity to get back in on my FTSE trade.
It’s been pretty profitable for us so far (see part 1 here and part 2 here). And today I’ll explain why I am looking to get back in on it again…
How robots are overrunning the market
There are two very different types of player in the financial markets.
First off, you’ve got your Fundamentalists. These analysts get the low-down on geo-political events and economics. They study anything that could affect stock prices. And they use a disciplined approach to value any stock.
Then there are the other lot – the Techies. Technical analysts don’t give a fig for fancy economics stuff.
They recognise that all sorts of things affect a share price – from price manipulation to a forced seller or even someone acting on inside information. Techies argue that you can’t ever really see what’s happening in the underlying market. So it’s better to just stick to picking over the stock charts and looking for patterns that you can trade.
There is a lot to be said for this approach. With automated computer trading becoming more prevalent, technical trading is becoming a key driver behind market moves. A huge amount of trading on the market every day is now done by machines looking to exploit technical patterns from one minute to the next.
MoneyWeek’s Tim Price points out that the average holding period for stocks has fallen to just 22 seconds in the US. That’s frightening! And it just goes to show how dominant this trading has become in recent years.
Not only is this sort of trading dangerous, but it can also cause massive market volatility in the short term.
Just look at the rally that we saw on Friday. There was little or no news to justify the FTSE suddenly bouncing back to 6000. In all probability, the techies just recognised the market had been overtaken with emotion. They recognised a pattern and started buying in.
The very fact that so many techies and trading robots use similar systems mean that these rallies can gather serious momentum – even when there is no news to justify it.
And that has some very important implications for private investors….
Don’t ignore the dark side
At my heart I’m a ‘fundamentals’ kind of investor. I firmly believe that economic and company fundamentals are the long-term drivers of stock prices. BUT and this is such an important but… emotions and ‘unknowable’ events drive short-term prices.
That’s why I never ignore charts. The best fund managers that I worked with used fundamentals to pick stocks and then looked to the charts to find the best entry and exit points.
And that brings me to my FTSE trade…
Recently I’ve been using some simple charting techniques to pick up some entry and exit points for the FTSE. But before even thinking about using the charts, I’d used the fundamentals to rationalise why taking a position would be a good move. With the central banks of the world on a loose money and QE mission, there was a good chance the markets would inflate.
As it happens my fundamental logic seems to have been about right. And I also think the recent rally will prove very short term. There’s more mileage in using the charts to find some profitable short-term trades here. So on Friday, I’ll be taking a look at exactly how we do that.
But even if you don’t like the idea of short-term trading, charting techniques should still be an important tool in your toolbox. Learning a few simple techniques can be a great help for timing your entry and exit points.
I’ll continue to focus on the fundamentals and when interesting charts crop up I’ll let you know.
Drop me a quick note…
These trades are a big part of why I enjoy writing Right Side each week.
I’ve always liked finding short, sharp trades like these and trying to turn them into a profit. And it’s a kick to write them up and share them with other private investors each week. So I hope you enjoy them to.
If you’ve managed to take a bit of a profit so far on the FTSE range trade, I’d be delighted to hear about it. Drop me a note at therightside@moneyweek.com
It would great to hear how you’ve done.
Until Wednesday
• This article was first published in the free investment email The Right side. Sign up to The Right Side here.
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Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.
Managing Editor: Frank Hemsley. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798
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