Email of the day
Comment of the Day

October 12 2012

Commentary by Eoin Treacy

Email of the day

on contrary indicators:
“ My query concerns contrarian indicators which I try to use in judging the early/latter stages of a medium/long run trend.

“ I generally look out for published articles with extreme +ve/-ve views e.g. article on Gold to hit 10,000 would be a contrary indicator. I also look out for what is actually making headlines e.g. BBC News @ 10 was broadcast from an Oil Rig when oil got close to $147/ barrel! Any advice on judging contrary indicators would be appreciated but I presume it is something you get better at judging with experience?

*Enjoying and benefitting your service; you both seem to have your finger directly on the pulse of the markets.”

Eoin Treacy's view Thank you for your kinds words and question which is sure to be of interest to the Collective. David Keller very kindly took me on a tour of the Fidelity chart room in Boston last week. One of the wall charts they maintain is of the S&P 500 annotated with little copies of the front covers of Time, Newsweek, the Economist etc. that appeared at market extremes. The chart offers a wonderful representation of enthusiasm and pessimism at major inflection points. It set me to thinking about contrary indicators, particularly in advance of the Contrary Opinion Forum.

A point often made at Fullermoney is that wildly bullish or bearish forecasts following an already well developed move are a better indication of how people have already positioned themselves rather than what position that are going to initiate. Logically, if I have a long position, I would sell if I thought it was not going to advance. Therefore if I continue to hold it must be because I believe prices are going to move higher. The important psychological subtlety is that many people require massive extrapolations to help justify their actions to themselves. The “I know I'm being reckless but it's worth it” defence.

The subject of contrary indicators is all the more interesting because most people are bad at predicting but tend to be overly confident in their ability. This means that a disciplined approach is essential if we are to avoid becoming our own best contrary indicator. This is an interesting section by Gustaf Törngren and Henry Montgomery from the Journal of Behavioural Finance in 2004:

“Studies assessing financial analyst predictions often give a rather gloomy picture of their validity. As early as the 1930s, Cowles [1933] showed how stocks recommended by a number of financial services in the years between 1928 and 1932 were outperformed by the average common stock. This trend continues today. De Bondt [1991] analyzed the results of a longitudinal study (1952-1987), and found that the experts could have improved their results by using historical means instead of specific evaluations. Similarly, Malkiel [1999] found that, from 1988 to 1998, the average equity mutual fund in the U.S. had a 3.3% lower average annual return than the Standard & Poor's index during the same period.”

Rather than concentrate on the novelty of an overly emotional media response, I believe the secret to contrary opinion is to attempt to understand the actions which led to such a response. These types of events are most likely to represent major turning points when price action has also accelerated away from a trend a mean such as the 200-day MA.

At The Chart Seminar, we describe acceleration as a trend ending of undetermined duration because in a rally, the available demand present at that time is being expended at an ever increasing rate. When everyone who wanted to buy has bought all that is left is potential supply. The opposite is true of a decline. Once this point has been reached a retracement is inevitable. This approach identifies widely perceived contrary indicators as symptoms of crowd behaviour rather than as ends in themselves. This helps to offer confirming evidence and avoids the temptation to misidentify events as climactic.

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