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Analysis, Perspective, Trading Strategy

Welcome to the Brave New Digital World Where Robots, Not People Move Markets

By Joe Duarte on May 13, 2018

After a successful sneak attack on the unsuspecting bears over the last couple of weeks it’s now decision time for the robots as the stock market continues to follow a digitally precise textbook case of technical trading while the news cycle becomes uncertain.

Two weeks ago in this space I notedI may be overplaying the contrarian card, but it looks as if the most under-loved stock market in the past eighteen months is setting up for what could be a fairly profitable trading rally.” I made this prediction based on the general tendency of robot trading algorithms to combine programmed responses to news headlines with basic technical analysis support and resistance levels to launch market moving trading programs. Furthermore because most technical traders don’t pay attention to the 200-day moving average, that particular chart area seemed like a ripe support level for a simple robot like sneak attack on the market.

Indeed, I was correct, and since I made that prediction, the S & P 500 has gained nearly three percent and has broken above what had been a key pivot point on the price charts near 2700. So now that the cat’s out of the bag, the real question is whether the robot traders will pile on and take SPX back toward the 2800 area or whether the rally is essentially over.

Leading Indicator Says Upside Momentum is back

Score one for the bulls as the market’s most reliable indicator since the November 2016 election; the New York Stock Exchange Advance Decline line (NYAD) made a new high on May 11. That one technical event suggests that the path of least resistance for the majority of stocks is now to the up side.

The bullish argument is further boosted by improvements in the RSI and ROC indicators based on the action on the NYAD.

Volume Remains Problematic

It’s hard to argue with the NYAD, given its record over the last eighteen months. Yet, it’s also difficult to ignore that while prices have improved the trading volume on the S & P 500 (SPX) is not particularly robust since the market bottomed a couple of weeks ago. Overall the index picture remains more positive than not but there is some nuance which may or may not be meaningful if the rally picks up steam as traders, human and algo, who missed the rally, are forced to pile on.

In contrast, the volume situation on the Nasdaq 100 Index (NDX) is a little bit worse that what you see on SPX, as the large technology stocks featured in NDX actually closed down on May 11, an event which generated a rise in negative volume, which is not something we would want to see repeating itself.

So while both SPX and NDX both sport positive Accumulation Distribution (ADI) credentials, SPX has a better money flow profile as both ADI and On Balance Volume for SPX are positive. And although much of that positive tone for SPX is due to the recent rally in the oil stocks and the steady performance of big cap health care stocks, it’s not a terrible thing to see.

Nevertheless, even if SPX continues to move higher, it’s important to see what happens to NDX, especially since the rally there ran into the resistance area formed by the big price gap from the March crash. In fact, since old technical analysis dogma dictates that all chart gaps are eventually filled it will be interesting to see if the bots read that line in the Technical Analysis 101 book of proverbs. If they did, and they are programmed to believe this old adage, we will see higher prices in NDX.

Expect the Unexpected

The market’s technical underpinnings are not perfect, but they are good enough to move stock prices higher in the short to intermediate term unless there is some external event that derails the rally or someone pulls the plug on the bots – literally – as there would be no one left but a few of us old traders left around to bet on stock prices. Of course there are no guarantees and anything can happen at any time especially in the current game of geopolitical chicken between the U.S. and the rest of the world.

For example, if you think that things have been too quiet after Trump ended the Iran nuclear deal you’re probably right. That story is not likely over as too many political careers around the world are on the line and few players have had time to fully think things through and recover from the event. But as time passes so can plans emerge and events unfold. Meanwhile, there is no way to predict how robots would trade a truly seismic completely extra terrestrial revelation regarding Iran and whatever else may or may not be connected to it if that sort of thing emerges.

What we do know is that algos trade headlines. Thus any unexpected and extraordinary turn in this story or any other, could well be the next algo driven market moving catalyst. So, even if the mainstream analysis sees something as a negative, what really matters is what the algos decide. Thus in the algo universe that same piece of “negative” news may be worth a 3-5 percent move to the upside in stocks.

Moreover, you could take this line of thought anywhere you want at this point. For example if Hawaii’s volcano problems extend to California - and if the sun decides to die tomorrow, etc. My point is that there is still risk in this market, but that right now the technicals are pretty good and in any event, the algos still hold the key as to what comes next.

This analysis may lead anyone to throw their hands up in the air. Yet even if it’s alarming, those investors who are cautiously long currently while using prudent risk management tactics are more likely to survive any Black Swan that’s out there lurking. At the end of the day, robots read headlines and react unquestioningly to the words. And when they react, the markets move.

Welcome to the brave new digital world where price action in the markets is not about what happens or what humans think should happen. In this world, it’s all about what the robots decide to do with their handler’s money.

Joe Duarte is author of Trading Options for Dummies, now in its third edition. He writes about options and stocks at www.joeduarteinthemoneyoptions.com.



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