The Han Solo Market: Trade with the Bots
but Don’t Trust them
By Joe Duarte on August 13, 2018
Han Solo once said: “I have a bad feeling about this.”
Human beings are creatures of Chaos, which makes them predictably
unpredictable. The thing about artificial intelligence (AI) is that
it’s just that- artificial - and thus it is to a certain degree more
predictable since it was constructed by humans looking to reduce the
Chaotic nature of humanity. So, if the market’s recent history holds
up, and the bots act as they have in the past, Friday’s bounce in the
stock market, which followed Thursday’s aggressive decline, might be
yet another opportunity to buy the dip and join the race to new highs
in the major indexes. Accordingly, since AI seems to buy every dip
along with their central bank cousins who are doing anything possible
to make Ms. Yellen’s prediction of no more financial crises in our
lifetime come true, stocks may yet again continue to move higher over
the next few weeks.
What could possibly go wrong? How about everything? But Maybe
This is not a natural state for the markets, or for the world. There
are too many things that seem to be on their way to regrettable endings.
“I have a bad feeling about this.” Thus at some point, the stock market
is likely to have to revert to the mean as reality sets in.
That being said, this time may not be that time when traditional
market rules return. Thus as traders we have to trade the trend. Strangely
enough, the trend’s next turn is likely to be decided over the next
few days, given the market’s short term oversold status. So if the
new trend is up, we’ll trade up. And if it’s down, we’ll trade down.
At any rate there is no need to be in a huge hurry as once the robots
pick a direction, they stick with it until the next textbook support
or resistance level. That is the operating mode for now, until the
bots change their tune.
Market Breadth Follows the Script
Machines are predictably programmed to trade based on simple technical
indicators. And they always follow a very simple script, which in this
case seems to have been that the New York Stock Exchange Advance Decline
Line (NYAD) fall precipitously for a couple of days, only to find support
at its 50-day moving average as it did in March. Even more eerie, and
machine like, are the nearly equal oversold readings on RSI and ROC from
the March bottom and the current bottom if it holds.
Over the last few months I’ve spent a lot of time analyzing the market’s
moves, concluding that the machines are programmed to use the most
basic technical indicators to execute trades. These include the RSI
and ROC – the former is a useful measure of the overbought or oversold
status of the underlying asset, to execute while the latter measures
the momentum of the current direction of prices. And, lo and behold,
as the NYAD fell to its 50-day moving average on Thursday, the RSI
and the ROC nearly hit oversold territory. On Friday, just as in the
Technical Analysis 101 textbook, the NYAD bounced and the market followed.
S & P and NDX Follow Same Script
It’s nice to know the robots are using a one size fits all script
to trade the market. This is fairly obvious given the eerily similar
chart for the S & P 500 (SPX) and the Nasdaq 100 Index (NDX) and
their equally creepy mirroring of the NYSE Advance Decline line.
Outside Fantasy Island: Real Damage inside the Smaller Stocks
It is quite plausible that we’ve seen the worst of the stock market
over the next few weeks, if you use the Nasdaq 100 and the S & P
500 as your benchmark. So if the robots do what they’ve done every
other time since the November bottom and your investments are designed
to mimic their performance, you’ll be o.k. until something changes
to reverse the uptrend in these market indexes or the robot’s programs.
But if you’re investing outside the robot’s sweet spot you may be
seeing something different. For example, as the big tech stocks have
been making new highs, the S & P Midcap Index (MID) has fallen
off the face of the earth. This deep in the heart of the market index
is very oversold now based on the ROC indicator showing a downward
momentum washout. But the Accumulation Distribution (ADI) and On Balance
Volume (OBV) indicators are testing rising trend lines that go back
to the November bottom, which means if these support levels are broken,
the selling in this area of the market, in which there are more stocks
than in the 600 (NDX + SPX) that are getting all the robot’s money,
is going to get worse.
So like in a zombie movie, when the hands that come out of the ground
start to grab the feet of the unsuspecting pilgrims trying to escape
the holocaust, if there is no improvement in the smaller stocks, the
odds favor the many pulling the few down.
What do I know?
I know. I might be over reacting. I may just be an old guy who doesn’t
understand how this new world works. After all, I haven’t changed my
Iphone in several years and I’m thinking of giving up cell phones altogether,
which makes me one big ol’ square peg. And although I’ve seen bulls and
bears rise and fall, wars start, develop, and end, bubbles fill and explode,
and all other types of major crises unfold, no one but my subscribers
seems to care, which is nice and cozy – being on TV is actually a bother.
Still, through it all, I trade what we see. So I’ll monitor the charts,
trade in a vacuum, and follow the bots. They’ve got the money. And they’ve
got the power. But I don’t trust them and neither should you. This is
a dangerous game. Play at your own risk and understand what you’re doing
and what you’re up against.
I’d like to leave with a quote from 1980 metal icons Judas Priest
and their song “Metal Gods”:
“Machines are taking all over - with mankind in their command. In
time they'd like to discover how they can make their demand.”
All I can say is: “I have a bad feeling about this.”
Sleep – if you can. Trade because volatility is back.
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