How to make money from markets you know nothing about
By
Dominic Frisby Jul 30, 2008
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The beauty of technical analysis is that it can enable you to trade a market you know nothing about. Last week I was able to make some pocket money buying and selling cotton. I don't know a great deal about cotton, and if I was to start analysing global t-shirt demand, I might quickly wither and die. But I do look at the chart most days and have become familiar with the patterns it traces out.
Similarly, if I get much more information about the state of the US economy, I think my poor little brain might explode. There is just so much noise. But, just by looking at a chart of the S&P 500 for the last couple of years, I could see that 1,280 was an obvious point for last week's short-covering rally to peter out.
I put out a sell order there and went off to pursue my daily business. Sure enough a stream of bad news came out when the S&P had in fact passed 1,280, the market turned down and I was compensated to a small extent for the hammering that gold and my junior miners took.
So today, I am going to look at a specific part of technical analysis, moving averages – and, in particular, 'golden crosses' – and how they can help you filter out the noise and make money.
How a simple chart can tell you if we’re in a bull or a bear market
Moving averages are a gloriously simple trading tool that can help clarify where you are in the grand scheme of things. If you're looking at a weekly chart, the 30-week moving average (30 wma) will show the average weekly price for the last thirty weeks; the 50 week-moving average will show the average weekly price for the last 50 weeks; and so on.
On a daily chart, people will often look at the 20-, 50- and 200-day moving averages (20dma, 50dma, 200dma). Longer-term traders concentrate on the weekly charts and shorter-term traders will look at the daily, hourly and, in the some cases, even the minute charts. But if you want to be a truly idle investor, look at the weekly charts. In a bull market they will be sloping up. In a bear market they will be sloping down.
Below is a chart of gold since 2001. Most chartists tend to use rounder numbers and the 30 and 50-week averages will work just as well here but, because I am stubborn old goat who always has to be different, I am using and 34- and 52-week moving averages. (I use 34 as it is a Fibonacci number – that’s a story for another day - and 52 because there are 52 weeks in a year). You will notice that the 34 wma is above the 55 wma and the actual price is above the 34 wma. That is the action of a bull market.
You will also notice that the price tends to return to the 52wma; the 34- and 52wmas then come closer together, and then the price breaks out again. These mark good entry points. When the price is too far above its weekly moving average (30-40%), it's usually a sign that it has got ahead of itself and it’s time to take some profits. You will also notice that the 34 wma has never crossed down through the 52 wma since 2000.
Now let's look at a chart of the S&P. The price is below the 34 wma, which is in turn below the 52 wma. That is typical of a bear market. Every now and then Hank Paulson or one of the other guys who’s supposedly in charge, says the US economy’s woes are “contained”, and the market rallies. But notice how it only gets as far as the 52 wma then sells off again. This is also typical of a bear market.
What is a 'golden cross' moment?
Now here's the good bit. This is the big sell point or the big buy point. When the 34wma crosses up through the 52wma and the price is above the cross, that marks a 'golden cross'. It tells you we have moved into a bull market. Some take that as an immediate buy signal and hop on. Some, like me, trickle some money in at that point, and then add some more when the price comes back and retests the 34- or 52-wmas, as usually happens. In gold, for example, this golden cross moment happened way back in 2001.
Similarly, when the 34 wma crosses down through the 52 wma that is your sell signal, marking a bear market. Often you can wait for the next retest of the 52 wma before you sell. Here you can see the nasty bear that is the US stock market.
Though it galls me to say it, junior miners are also in a bear market. True adherents of this strategy would have sold back in late 2007.
So what's the conclusion to all this? Well, if you stick to the golden cross strategy you will make money over time. Look at Mark Shipman. He is one of the best traders of his generation. He uses this strategy like mad, as you can read in his two excellent books – Big Money, Little Effort and The Next Big Investment Boom. He says over time they're the most reliable ways he's found of making money. But the key is, 'if you stick to the strategy'.
So what does this technique tell us about where we are now? As if you needed telling, gold is in a bull market. Oil is in a bull market, but has got too far ahead of itself and is now correcting, probably back to the 52 wma. And stocks are in a bear market. So be long gold, long oil (but not right now, as we point out in this week’s MoneyWeek cover story), and short stocks overall.
Turning to the wider markets…
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UK shares nudged better, with the FTSE 100 index gaining 7 points, or 0.1%, to 5,319. Financial stocks lagged yet again, with the banks in the doldrums after the previous day’s large write-downs from Merrill Lynch. Royal Bank of Scotland lost another 4% as did Barclays, while HBOS slipped 5%. And insurer Legal & General slid 2.4% over fears its share buyback programme won’t be extended. But miners extended their previous day’s gains, as Vedanta and Xstrata both climbed 2%. Marks & Spencer advanced 5% on director buying and vague talk of a private equity bid.
Shares also picked up in Germany, with the Xetra Dax gaining 0.8% to 6,399, although the French CAC 40 eased 0.1% to 4,320.
US stocks more than recovered the previous day’s losses as oil prices fell and several companies reported better than expected earnings. The Dow Jones Industrial Average jumped 266 points, or 2.4%, to 11,398, while the wider S&P 500 put on 2.3% to 1,263 and the tech-heavy Nasdaq Composite climbed 2.5% to 2,320.
Overnight the Japanese market also advanced, rising 208 points, 1.6%, to 13,368 while in Hong Kong, the Hang Seng added 375 points, 1.7%, to 22,633.
This morning commodity prices were generally weaker. Brent spot was trading at $122, spot gold at $917, silver at $17.31 and platinum at $1757.
In the forex markets this morning, sterling was trading against the US dollar at 1.9806 and against the euro at 1.2698. The dollar was firmer, trading at 0.6411 against the euro and 107.95 against the Japanese yen.
And also this morning, Lloyds TSB kicked off the UK banks’ reporting season with news of lower-than-expected interim profits, which came in 63% down on last year, after asset write-downs.
Our recommended articles for today:
The real reason you should buy gold – and how
Gold is a fashionable investment at the moment - and it is a sensible one. But rather than putting all you've got into the stuff, you should use it as a hedge against tough markets. Here's one way how.
http://www.moneyweek.com/file/51346/the-real-reason-you-should-buy-gold--and-how.html
Tap into the new wave of energy generation
High fuel prices have meant a rush towards new ways of generating energy. Many ideas never make it off the drawing board, but microturbines - clean, portable and efficient - could be a big part of our future.
http://www.moneyweek.com/file/51349/tap-into-the-new-wave-of-energy-generation.html
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Dominic Frisby
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