Stock Market Behavior: Separating Signal from Noise | Filling the Gap in the CMT Association

My initial intention was to focus on the number of major stock indices that are nearing all-time highs or attempting to break out of their long-term ranges, and whether their behavior around previous highs in the coming months will provide important insight into what’s coming next. Yes. . It evolved into something else, which I will share with you here.

Understanding the Randomness of the Stock Market

I am convinced that most market movements are random and mostly untradeable noise. But most people who work in the financial markets for a living have to translate meaningless actions into ongoing stories for their customers and employers. The important point is that once a narrative is expressed publicly, analysts/traders become locked into that narrative, which in turn carries with it any behavioral biases identified with that view. Working in an institutional environment, my solution was to focus on longer time frames.

When a pattern occurs in the right place on the chart, it becomes much more valuable and actionable.

Part of the evolution of being a technologist is finding the style that best suits your emotional and risk management tolerance. For me it has been a long and sometimes painful journey. One of the most difficult challenges was finding a systematic approach to separate signal from noise. In other words, when is market behavior important and when is it not important? If so, how can you trade later to take advantage of your informational advantage?

Anyone who has traded for a living knows that market behavior and patterns are often unreliable. This is especially true if they occur in trending markets and are far from any real support or resistance (the most obvious exceptions are early-stage trends and climax/conclusion structures). do not misunderstand. Systematic entries centered around trading against established trends can work well. However, I prefer to take early positions on early-stage trends, where I can have tighter control over risk management and where my macro opinions, which differ from the dominant market narrative, are more likely to be catalysts for change.

When a pattern occurs in the right place on the chart, it becomes much more valuable and actionable. To be fair, I don’t discount the daily shift. Having observed tens of thousands of charts over the years, I’ve gotten a good feel for short-term fluctuations. However, I place less emphasis on creating trading plans or adjusting positions accordingly and try not to mark them as anything more than short-term trades. In these cases, my chart analysis usually consists of a high-level look at the price-volume relationship and a general view of the chart. On the other hand, a solid confluence of well-defined support and resistance on a weekly and monthly basis is my wheelhouse. When I find these markets, I focus heavily on them.

Along the way, I actively explore the market and test well-defined price breakpoints on a weekly and monthly perspective. At these points, a combination of price/volume action from a daily, weekly, or even hourly perspective makes sense and often produces actionable insights.

As a professional bond trader, I have always envied the unconstrained traders who have thousands of global stocks, stock indices, currencies and commodities to choose from across a variety of time perspectives. Fat pitch is always set up somewhere, as long as you’re persistent enough to find it.

On the charts!

Several global stock markets are testing important previous highs, many of them on a monthly perspective and others on a weekly perspective. This is a situation where signal quality is high, price/volume relationships become more important, and often new trends are set for quality risk reward tolerance.

These are all charts that have recently been moved to my watchlist.

MSCI Italy Capped ETF

The iShares MSCI Italy Capped ETF (EWI) is a representative example of this.

Chart 1. EWI monthly chart.

Italy is just above the upper end of its 20-year trading range. In this position, even small daily changes in perspective generate meaningful information. Importantly, because a long trading range acts as a potential trigger, the potential breakout target is much higher and even a miss back to the low of the trading range can result in returns of roughly 40-45%. It’s very simple. The market is one of:

• A) You are leaving or
• B) It sweeps the top of the range, sucks the weak hand, leaves the weak hand trapped and will soon fail back to the range.

Reviewing the chart, I initially thought this was actually outside of a 10-year trading range.

• The September 2022 low (B) was higher than the previous low (A).
• There were significant signs of accumulation during the final decline towards the lower range (34.53-20.99).
• The market is just above the most immediate horizontal resistance (34.45-34.53) and just above the 36.88 resistance line.
• After the breakout, corrections most often took the form of bull flags or pennants.

However, there are some caveats.

• Momentum was significantly overextended in all periods.
• There is a risk that the slow weekly stochastic could diverge and roll over.
• The monthly slow stochastic is attempting to roll over.
• EWI is close to the upper end of the daily, weekly and monthly Bollinger Bands.
• Several price channels have reached a confluence in the 38.00 area on the chart.
• As markets have rebounded over the past 19 months, trading volume has decreased significantly. This means that there is insufficient selling pressure rather than high demand.
• Since 2011, peaks have been in the mid-40s. It is currently 35 months old.
• Although higher than most recent resistance, the 2009 high of 43.54 would provide strong resistance.

Let’s say the market is ready to pull back. In this case, price-volume relationships, patterns, actions related to support and resistance areas, and other traditional technical relationships can provide early entry into the next meaningful directional move.

For now, we suspect the market will break out long-term, but the high number of concerns on the list suggests a downside is likely before the next strong trend phase begins. The behavior of the pullback and where it holds (where the CD resistance is most likely broken) will be important (see chart below).

Chart 2. Watch for the pullback to hold at EWI’s CD resistance.

Nikkei 225

The Nikkei is another major market testing record highs. The monthly chart below shows the index is at an all-time high and at the top of the channel. This is definitely a chart to add to my watch list.

Chart 3. Monthly chart of the Japanese Stock Market Index (JP225).

MSCI India ETF

India is interesting. There has been a very positive shift in reports on India’s economic outlook, with markets recently hitting record highs. However, note the increased volume and low upside that comes with that volume (see the monthly chart for the iShares MSCI India ETF (INDA) below). I suspect strong hands are selling the rally.

Chart 4. Monthly chart of iShares MSCI India ETF (INDA). Finally, many of the topics and techniques discussed in this post are part of the CMT Association’s Certified Market Technician curriculum.

disclaimer: Shared content and published charts are for informational and educational purposes only. CMT Association does not provide this information, and this information should not be understood or construed as financial advice or investment recommendations. The information provided is not a substitute for the advice of an investment professional. CMT Association will not be liable for any financial loss or damage that may occur to the audience.