Technical Analysis in Event-Driven Markets: When Consumer Spending Is Down, the Fed Will Cut Rates in Response and Then the Market Rallies. When Consumer Spending Is Up, Inflation Is Coming and the Market Falls. What's Bullish One Day Is Bearish the Next, and Vice Versa. Smart Traders Don't Trust the News. They Turn to Technicals

By Greenblatt, Jeff | Modern Trader, March 2009 | Go to article overview

Technical Analysis in Event-Driven Markets: When Consumer Spending Is Down, the Fed Will Cut Rates in Response and Then the Market Rallies. When Consumer Spending Is Up, Inflation Is Coming and the Market Falls. What's Bullish One Day Is Bearish the Next, and Vice Versa. Smart Traders Don't Trust the News. They Turn to Technicals


Greenblatt, Jeff, Modern Trader


Event-driven markets are a common deterrent to many would-be technical analysts. After all, how can lines on a chart make sense of a market that appears to change direction on news events? A common refrain on business news programs during the recent credit crisis has been that the markets "are no longer trading on the fundamentals." Other people thought that the markets were no longer trading on technicals. Most didn't know what to think.

Thankfully, there is light to be shed on this topic. With the right technical tools and know-how, any trader can navigate these rough financial seas.

In his acceptance speech for a lifetime achievement award in service to this industry, legendary trader Richard Arms told the audience that everything anyone ever wanted to know about a stock or index could be found on a price chart. The price chart encompasses all of the hopes and fears of each market participant, and those hopes and fears are reflected in the current price. The technical situation not only reflects supply and demand but fear and greed. If you can wrap your mind around that concept, the battle is half won.

It's a common notion that news drives price action. In reality, the opposite is true. The current technical situation, as expressed by universal price and time relationships, drives future price action. This is true in every case. We are only limited by our understanding of what materializes on a price chart.

IT GOES BOTH WAYS

The challenge for many traders is that the technical situation may be too complex to understand. During these times, it's tempting to assume certain price moves are driven by current news or events, and, worse, trade on those assumptions. Luckily, technical situations aren't always so complicated. There are enough situations where price and time make sense and most traders can put the pieces of the puzzle together.

On any given day, the media spins its explanation for current market action by the major news story of the day. On some days, a market decline will be blamed on rising unemployment. On other days, a major company layoff will be credited for a market rally; these apparent anomalies should inspire doubt for the diligent trader. Bull markets climb a wall of worry, and in a bear market, we slide down a slope of hope. Markets will do what they must based on the technical situation; as a result, it often appears they are looking for an excuse to move toward a specific technical target.

A simple concept that is nonetheless sometimes difficult to grasp can help explain this. Markets move in three dimensions: price, time and volume. When markets hit price and time targets, the news event seems to manifest. You can never know what that event will be, but it seems to work over and over. This phenomenon has been going on for years, but 2008 was a historic period when many events materialized within the space of a few months. Because this was an unprecedented condition for our generation, many did not know what to make of it.

SEE AND LEARN

A few examples can help illustrate this concept.

One that had a major impact on markets was the July 15 low that sparked a decent bear market rally. The bear market was correcting the excesses of a real estate and banking crisis. Consequently, the housing and banking sectors led the market down.

On July 15, the KBW Bank Index (BKX) hit an important technical price and time cluster (see "Don't bank on it," right). The Futures articles "Trading Stocks with Fibonacci and Lucas" (May 2007) and "Finding Patterns with the Lucas Time Series" (September 2006) further explain how the time dimension of technical analysis can give the trader an edge in recognizing these patterns.

One repeating technical setup is a Fibonacci expansion based on the last leg of the old trend that projects important lows of the new trend. On July 15, the BKX came within ticks of the 2. …

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Technical Analysis in Event-Driven Markets: When Consumer Spending Is Down, the Fed Will Cut Rates in Response and Then the Market Rallies. When Consumer Spending Is Up, Inflation Is Coming and the Market Falls. What's Bullish One Day Is Bearish the Next, and Vice Versa. Smart Traders Don't Trust the News. They Turn to Technicals
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