TRADING/INVESTMENT STRATEGY AND TACTICS

Strategy is understanding the season. Tactics are deciding if we need to take an umbrella today or if we should put on sunscreen. Often strategy and tactics are in agreement – using an umbrella in Autumn. Sometimes they are less compatible which is why people in Autumn are also prepared for quite warm days. The market condition is similar. The strategy messages are sounding caution, but tactically there are many opportunities. Part of this confusion comes from the difference between a rally and a trend.

But first, here is a chart that continues to frighten us. The first is the DOW performance during 1929-30. It shows the fast rally rebound that lifted the market 48% before dumping it again into the collapse of 1930 and 1931. The market also rose again with rallies of between 23% and 35% on several occasions in 1930 and 1931. Great trading, but shocking investment opportunities. This type of situation remains a possibility even in these apparently ebullient times where many public figures are pronouncing the end of the recession. These are in many cases the same figures who were unable to identify the start of the recession.




The second and third chart highlight the difference between a rally and a trend. We are accustomed to thinking of a rally as a short lived up move. Time is a factor in separating a rally from a trend, but it is not the most important factor. The difference between a rally and a trend is the way the trend tests and retests a rising support line, or trend line. A trend has a pattern of rally, retreat, rebound, rally and retest of the trend line. This is shown in Chart A which is the Hang Seng index. The April retreat is a significant ‘stress test’ of the trend and it finds support at the lower edge of a long term consolidation support and resistance area that has been developing since September 2008.



There are two other important supporting features. The first is the consolidation pattern of sideways trading in a band over several months from October through to March. This provides a foundation for the trend breakout.

The second is the character of the retreat and rebound. The rebound develops from the upper edge of the long term GMMA. Additionally, as this retreat develops there is no compression in the long term GMMA. The market absorbs this retreat. Investors step in as buyers because they believe this retreat is an opportunity to join the rising trend. The width of the long term GMMA shows investors support for the trend.

Rally behaviour is different. A rally has a single trend line that has not experienced any significant rally and retreat behaviour. This is chart B, the DOW. It is difficult to place an accurate trend line on the DOW chart. The trend line that most correctly defines the behaviour is shown. Note the key difference. There is no rally, retreat and rebound behaviour in this period. It is simply a series of minor tests of the support function of the trend line. This behaviour underlines the rally characteristics of the DOW.



So here is the nasty question. If a trend includes a rally, retreat and rebound then where is the rebound point for the DOW when the current rally collapses? In this ‘stress test’ where is the bottom lime located? There is weak support near 7500 based on the spike lows in November. Or there is support near 6500 from the March 2009 lows.

The separation in the long term GMMA is narrow. This shows there is not strong support from investors. This narrow band also provides every weak support for any market retreat. Unlike the Hang Seng there is a low probability investors will step into the market and buy as the index falls. There is a higher probability they will join the selling and accelerate the continuation of the downtrend.

Fear and caution should not blind us to the opportunity to identify good trading opportunities. There are excellent returns available from rally and prolonged rally behaviour in individual stocks. However, the strategic outlook suggests it is too early to treat these as investment opportunities. We trade for profit and act with caution.

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Daryl Guppy, well-known international financial technical analysis expert. Appears regularly on CNBCAsia and is known as "The Chart Man". He is an equity and derivatives trader and author of books including Share Trading, Trend Trading and The 36 Strategies of The Chinese For Financial Traders. He has developed several leading technical indicators used by investors in many markets. His weekly analysis newsletters get favorable comment in Asia and Australia.