In the way of a refresher course, the efficient markets hypothesis (EMH)
proposes that global financial markets are efficient in terms of the information
available to investors and traders that drives prices. Another way of looking at
the efficient markets hypothesis, which has influenced much of the investment
thinking around the world in recent decades, is that based on the information
available, you cannot achieve risk-adjusted returns in excess of the average
market returns over time. The efficient markets hypothesis is the sister
hypothesis of the random walk hypothesis, which essentially states that the
direction of prices in markets cannot be predicted.
Many have taken issue with both the efficient market hypothesis and the
random walk hypothesis. Of course, the most notable is Warren Buffet, who said.
“I’d be a bum on the street with a tin cup if markets were always efficient.”
Clearly, Buffet’s performance has demonstrated that markets are not efficient,
as he has consistently beaten the averages. His $5 billion dollar bet on Bank of
America may help him revert closer to the average, but here we digress.
What Buffet is suggesting is that there are methods of analysis that allow an
investor to beat the market, and have allowed him to do so handily. Buffet
applies methods of value investing analysis, and good gut instincts on
management, to beat the averages. It was Warren Buffet’s mentor, the
world-renowned value investor Benjamin Graham, author of The Intelligent
Investor, who advocated investors develop what he called “formula timing
plans”, to determine optimal times to enter and exit value-based investment
selections. The following is what Benjamin Graham had to say about formula
timing plans:
“I am more and more impressed with the possibilities of history’s repeating itself on many different counts. You don’t get very far on Wall Street with the simple, convenient conclusion that a given level of prices is not too high… In recent years certain compromise methods have been devised by which the investor can take some advantage of the stock market’s cycles without running the risk of an unduly long wait or of “missing the market” altogether. These are known as Formula Timing Plans.”
Benjamin Graham is clearly suggesting that market cycles be used to identify
opportunities to buy and sell, and the mounting evidence in the field of market
cycle dynamics suggests he is correct. He was clearly referring to applying
various methods of technical and fundamental analysis that allows the
identification of what Ecclesiastes refers to as, “A time to buy and a time to
sell.” Benjamin Graham proposes a formula timing plan in addition to applying
principles of value investing. This idea runs highly contrary to the concepts
behind the efficient markets hypothesis.
Value investors have clearly been punished along with all other investors in
recent years for not recognizing the market cycle dynamics at work. The question
for all investors, and certainly traders, is whether there are methods of
technical analysis that allow you to identify entry and exit opportunities in
price and time consistently enough to allow you to beat the averages. Technical
analysis essentially proposes that there are in fact methods that can be added
to various investment approaches to create a formula timing plan to beat the
averages.
PQ Wall was fond of saying, “Pattern is the sunlight of the mind.” Technical
analysis basically proposes that there are patterns at work in markets that
allow an investor or trader to anticipate and identify market turns in advance.
Technical analysis recognizes that there are technical patterns that can
override the fundamentals of a market or specific security.
There are an almost unlimited number of methods of technical analysis applied
by both investors and traders seeking to improve their odds of beating the
market averages. There is tick, trend, Fibonacci ratios, Elliott waves, Gann
fans, advances/declines, accumulation, moving averages, moving average
convergence/divergence (MACD), and the list could go on. Many technical analysis
practitioners have proven to apply technical methods to beat the averages with
different formula timing plans.
Investors and traders should identify and develop a formula timing plan that
suits their investing style and philosophy. It should be a plan that has proven
over time to identify opportunities to buy and sell on a consistent basis. After
studying the technical market masters for decades, I have developed Market Cycle
Dynamics (MCD) formula timing plan as a relatively straightforward method with
the goal of identifying when to buy and when to sell. It can be applied by both
long-term investors and short-term traders.
MCD uses 1) price, 2) time and 3) sentiment to anticipate turns in any global
market or security. For price, MCD uses new Fibonacci methods and drill-down
price grids to identify high probability multi-year or intraday price target
turns. This is similar to the Wyckoff method that identifies support and
resistance lines, only MCD uses Fibonacci grids and price targets. Specific
Fibonacci grid targets provide specific and clear entry, exit and stop loss
prices. However, time can be just as important as price. MCD uses a new method
of time cycle analysis based on ideal time cycle lengths and their Fibonacci
ratios, which have been studied and documented for years. For market sentiment,
MCD uses stochastics, which can identify when a market or security is making a
high probability high or low.
When a market index or a security is approaching an important Fibonacci price
target in a “hot” Fibonacci price grid that has identified turns in the past,
you should always pay attention. If this is occurring in a time cycle window
where you are looking for a top or a bottom you need to pay closer attention. If
price and time has your attention and stochastics are indicating that the
sentiment of investors and traders is overbought or oversold, you have an
opportunity to take action and beat the averages. Can you do it on every
investment or trade? No, but a solid formula timing plan will help you preserve
your capital, increase your risk adjusted returns, and you can do it often
enough to beat the averages.
Global markets are in the final business cycle of the Kondratieff long wave.
The chart below is an example of price, time and sentiment in the rally since
the March 2009 lows. You can clearly see where price, time and sentiment
converge to trigger a high or low in the market at an important turn. These
targets are where the MCD formula timing plan provides you with an opportunity
to buy or sell. The chart demonstrates the unfolding cycles tracked by the MCD
formula timing plan. Note the high and low levels in the stochastics as the
S&P 500 approaches Level 1 Fibonacci grid targets. Mr. Market is currently
trying to put together a rally in the latest Wall cycle, but this is Wall cycle
#6, and is expected to be a third last and weakest cycle that tops early and
dies hard. It will be a short cycle unless QE3 comes to the rescue.
Applying the MCD price, time and sentiment approach
to an individual security is demonstrated in the chart below of Proctor &
Gamble (PG), a large cap global franchise company with a higher dividend than
most companies. The chart demonstrates an ideal Wall cycle in time, the
Fibonacci Level 1 and Level 2 price grid, and investor and trader sentiment in
the daily 55 period stochastics. The low in August created a buying opportunity,
but the rally from that low met resistance at the Level 1 76.4% target price of
$63.62 with stochastics approaching overbought status again. In light of the
larger cycles putting downward pressure on global markets, long-term holds are
generally not advised at this time.
Just looking at the business cycle and the smaller cycles is not enough.
There are now forces in play in the current global economic crises that are much
larger than the business cycle, name the long wave winter season. They are
putting great downward pressure on the business cycle and global markets. Great
caution is advised for investors and traders.
While we are on the subject of the efficient markets hypothesis and the
random walk, the chart below of Australia’s ASX is of interest. The chart is a
1-minute intraday chart of the Level 3 and Level 4 grids. These grids are
generated using the 1991 Level 1 low of 1202.54 and the 2007 high of 6873.20 and
drilling down to the Level 3 and 4 grids. That price action and the 21 period
1-minute stochastics don’t look very random to me. It looks like a combination
of natural Fibonacci forces and computer programs. This is an intraday version
of what happens in the larger cycles.
If market price movements are efficient and random, and their direction
cannot be predicted, why is the ASX finding support and resistance turning
intraday on the Level 3 Fibonacci grid prices with precision? The answer is
twofold. First, Fibonacci ratios are a natural occurrence in markets, and
second, the quantitative analysts “quants” that write the computer programs use
the Level 1 highs and lows and Fibonacci ratios in their algorithms. MCD
provides quant-busting power to investors and traders by drilling into the
Fibonacci price grids.
Finally, the DAX is of particular interest for the MCD approach. It is
remarkably oversold due to the European sovereign debt crisis. Most markets held
earlier August lows, while the DAX has dropped through the Level 1 golden at
5542, which was critical support and is now critical resistance. If the DAX
falls through the Level 2 76.4% target at 5161 and then the 61.8% golden ratio
target at 4926, the European debt crisis may envelop the world sooner rather
than later. Alternatively, price, time and sentiment suggests the DAX is spring
loaded for the Wall #6 rally. Either way, investors and traders have specific
prices for entry, exit and stop losses to take action. If the DAX rallies here,
Wall cycle #6 is expected to die young, hard and fast.
Investors tracking large cycle turns and traders tracking small cycle turns
to buy or sell can apply the MCD approach of price, time and sentiment to any
global market or security. Tracking the market cycles in price, time and
sentiment as an investor or trader can increase your odds of beating the
averages, debunking and helping send the efficient markets hypothesis to the
dustbin of history.
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