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 noted “I 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
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
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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