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Inferences From Technical Indicators About the Stock Market May Be Invalid

Technical traders ought to be very careful with any inferences made from technical indicators about the future course of the stock market. The reason is that indicators may be out of whack due to market manipulation and invalidation of technical signals. The errors may have accumulated to a level that any longer-term signals are useless.

For example, let us look at the golden cross. Due to a prolonged manipulation period of stock prices via quantitative easing the current golden cross in S&P 500 has been on for 755 days, as shown on the chart below:

SPX_20150130_50_200

One question that arises is the following: Does the golden cross in S&P 500 actually reflect market strength? The answer is that it reflects interventions that have caused V-bottoms in an effort to stabilize the market and push it higher. Any technical information and inferences made from using this or related indicators reflect not a primary but a secondary process that involves compliance of the indicators with fundamentals. This continuous compliance in recent times has caused errors to accumulate. Therefore, it may be the case that this golden cross in S&P 500 does not mean anything technically.

Let us look at the Hurst exponent that, by the way, has rallied in the last few days and this has made me skeptical about the possibility of a shift that has occurred in the lower threshold level that signals a major top:

SPY_20150130_HURST_1

Although the exponent was on a downtrend after the 2011 correction and towards the 0.4200 level that in the past has signaled major tops, the persistent manipulation of the market caused leveling of values above 0.4400. Then, the Hurst exponent started rising and on Friday it crossed above 0.4800. This could indicate at least two things:

(1) Another uptrend will start soon

(2) The level for a major top signal was shifted to just above 0.4400 due to manipulation of prices, as shown on the above chart.

No surprise, this is the way technical analysis works: there is never a definitive answer and there is always plenty of ambiguity. Above I listed two diametrically opposite alternatives, i.e., a market top or a new market uptrend. This is how it works and even the market does not know what will happen as the final direction usually depends on some known and unknown factors. Anyone who claims to know the answer is a charlatan. Just pick your preferred direction and assume your risks. This is how the market works. Optimists often choose the long side and pessimists choose the short side. Historically, the pessimists have gotten burned badly. However, occasionally some of them make big gains betting on disasters. There are some optimum strategies that take advantage of both possibilities above, (1) and (2), but they are beyond the scope of this blog. The conclusion here is that technical traders should not rush to make inferences from technical indicators because they may be out of whack.

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Disclosure: no relevant positions.
Charting program: Amibroker
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