Fooled By Randomness

Every so often someone publishes a book proving without a doubt that there are no patterns in the stock market and that people who adhere to the tenants of TA are being "fooled by randomness." The book becomes a best-seller and everyone who is too lazy to investigate the premise on their own goes - see, I told you so.

What I find most incredible about this is that it is often said by people who believe that monthly housing start data actually means something important.

What could be more random than "monthly housing start data"? Or "weekly unemployment figures"? Or "monthly CPI figures"? (Coming by the way on Wednesday). Or "consumer confidence percentage changes"? Or any number of other government reports that economists live and die with?

These reports are absolute crap. Why do I say that? Because each report has a life cycle of exactly one day if that - what shocks the market today is forgotten tomorrow and we are on to something new.

Trust me when I say this - the market goes up and down based on supply and demand - if something is being offered in great quantities with little demand the price will go down and vice versa. The basic principle of economics is that the greater the price of something the more of it will be produced and the more of it that is produced the lower the price will become. And once the price hits some magic place where no one will offer any more - the price goes back up.

That's why when housing starts come out on a Friday and they don't ring some magic chime you get this effect -



Now let me just ask you what do you see in the first three candles of this chart - those of you who answered "an opportunity to make a buck" can sit up here in the front of the class.

You see, what happened was an overreaction to a bullsnot report that everyone knows is bullsnot. Then all of a sudden someone else noticed - wow - a chance to make some money and they started taking the offers. The third candle suggests a "short squeeze" and the opportunity to make some easy cash presented itself.

I wasn't watching housing on Friday - still licking my wounds from last week's beat down - but next time some bad report comes out - start watching the industry or industries that might be affected - maybe you can make a few quid by being "fooled by randomness".

BOB and BOT

I found a good example of a Blow-off Bottom followed weeks later by a Blow-off Top. I'm using a weekly chart to show how the BOB (and BOT) can be found from minutes to months. Once more the rules are simple -

Blow-off Bottom - two red candles where the low of the second candle is lower than the low of the first. The volume of the second candle is greater than the volume of the first. These are followed by a third candle (green/white) where the third candle's low is higher than that of the second. At least one candle of the first two should close below the EMA 8 as a minimum (less than EMA 4 is best). See the circle in the chart below. (For purposes of full disclosure - the third candle in this sequence is also a cross over).



Blow-off Top - two white/green candles where the high of the second candle is higher than the high of the first one. The volume of the second candle in the sequence is less than the volume of the first candle. The third candle is red and the high of that candle is lower than the high of the second candle. At least on candle of the first two should close above the EMA 8 as a minimum (greater than EMA 4 is best). See the rectangle in the chart above.

Now - when you see a blow-off top you should probably do one or both of two things - first - end any long trades you have in place, second - sell the stock short.

This is not an invitation to speculate - don't be fooled by randomness - we all know that there is no such thing as a pattern that repeats itself so consistently as to earn a silly name such as Blow-Off Bottom or BOB - don't we? And something even sillier like a "cross over pattern" couldn't possibly exist - could it?