Price Action That Repeats = Opportunity
As investors and traders our goal is to profit from future moves in prices of the assets we buy or sell. We obviously all use different techniques to try and predict what these future moves will be which includes anything from astronomy to economics to cash flow to technical anlaysis and everything inbetween. Some like myself like to use a combination of few different techniques and placing greater or less emphasis on any one method, depends on what my actual investment goal is - short-term, long-term or even which asset class I am trading.
When trading one asset class or stock regularly over time, you may begin to notice that certain techniques work better than others. Certain technical indicators are regularly useful and predictive on one stock and completely useless on another. Even fundamental techniques need to be adjusted and fine tuned and exceptions made for different companies - even within the same sctor. It really is a game of experience and trial and error.
In a book called the "Winning investment habits of Warren Buffet and George Soros", author Mark Tier highlights some very key points that help understand what makes these two investors (amongst other professionals) so different from the rest of the crowd. Importantly they are not skills that you or I cannot develop. One of there key advantages is their "knowledge library". That is, they have traded, invested, researched - won and lost- that many times over a prolonged period of time that they have an extensive library built up in their minds that they can make investment decisions quickly and assess the pitfalls, dangers and risks in an instant. It is said Warren Buffet only needs to ask 3 question of a business owner to assess whether he will buy it or not. They have a sixth sense or gut feel which comes from winning and losing thousands of times over. Novices will say it is 'gift' but in reality it isn't. It's time spent navigating every kind of market terrain possible.
So as investors the more often we trade, watch and analyse specific assets, markets and stocks the more we build up this knowledge library that is commited to memory. Unfortunately it does take time. However, it wont take long when you begin to know what to look for and understand how and why they happen.
I showed in the past month or so how 2015 had unfolded identically to 2011 and we were able to map out how to profit from the decline and subsequent rally. The trigger to identifying that was purely recalling the similarities in the behaviour of markets to when I was trading in 2011 and recognising the similarities in price action and market drivers. Further research and going through my historic reports (i have every piece of analysis i have ever written on file) uncovered this opportunity.
The key is understanding that the drivers here to a repeat of the price action is the natural reaction that traders and people have to the same set of circumstances. Humans will react the same way over and over to danger, fear and euphoria. Financial markets too. Natural human reactions repeat themselves.
When trading the same markets and stocks over and over, you begin to understand how they behave during different circumstances and cycles. And quite often these repeat. What works once as a profitable trade is likely to work again when the similar conditions appear.
Take for example Facebook. Leading into the last quarterly result in June I highlighted that the stock was beginning to break out from a 3 month consolidation that was supported by several technical indicators suggesting the stock would make an assault at $100 as the date of its earnings result approached in early August. This is a characteristic that many of the momentum, "new or disruptive" technology companies were doing including Amazon, Tesla and Netflix.
Fast forward to this quarter and ahead of Facebook's earnings releas eon November 4, the share price is again showing the same price action and behaviour. Even the technical indicators are almost identical. Lets take a closer look. The share price has broken higher from a 3 month consolidation that was capped by trendline resistance of identical length and slope to that in June. Next, the RSI indicator has also broken up from its own 3 month base that was contained by the 61 level. The exact same level as in June. Following on from this the MACD indicator has also moved above the zero line and beginning to accelerate at precisely the same levels.
These similarities reflect the optimism that regulalry builds in Facebook as its earnings release date approaches. Much of the profits made in Facebook come before the earnings release and as traders aware of this, the same trade that worked last quarter can be repeated again. The last rally saw a gain of $16 and repeating that same sized rally generates targets towards the $111 to $112 zone.
Investors get excited about the potential in Facebook largely due to ongoing stats being released by the company. Numbers like 1 billion people logging into Facebook at the same time or how many users they now have across their various platforms like Instagram and What's App. New measures to monetise their user base also excites investors who buy in anticipation of a strong profit result.
What I have shown here is not rocket science or something that takes decades of experience to learn. A simple study of the chart and looking for repetitive patterns over time that give clues as to the character and behaviour of the traders in Facebook and an understanding of "why" it behaves in such a fashion. When similar circumstances appear - like excitement over new products/revenue drivers ahead of an earnings release - we know what is the likely outcome in the share price and we can begin to position ourselves to profit.
So its not just the same boom to bust business and economic cycles that repeat themselves but price action on a smaller scale for individual stocks. Looking at the charts and behaviour of stocks will ensure that you can train yourself to be aware of more than just one dimensional theoretical chart patterns. It helps add to your knowledge library and your profits too.
Greg is the Head of Proprietary Trading at Global Prime and has over 20 years of experience as proprietary trader and high level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank. He has been involved across all asset classes including commodities, bonds, currencies and equities right across the globe.
After a 10-year career within the comforts of the large investment banks and research firms he branched out on his own to form his own proprietary trading firm successfully building the business into a multi-million dollar trading operation that turned over a billion dollars a year. This same team now runs the proprietary trading desk at Global Prime, risking their own money in line with the firm's and client's capital.
Greg has appeared on CNBC, Channel 9 - Business Sunday programme, a guest columnist for the Australian Financial Review, a regular author for Personal Investor, Wealth Creator and Shares magazine and is the former Treasurer of the Australian Technical Analysts Association.