-- Posted Monday, 11 May 2009 | Digg This Article
| | Source: GoldSeek.com
By Howard S. Katz
The Triangle
This continues the review of technical analysis which I began in my April 20, 2009 article. At that time, we reviewed the saucer bottom and the resistance level represented by a former high. We also discussed Thomas Aquinas’ theory of the fair price and how the vast majority of the people make the mistake of believing this. This makes it possible for us to know how they will behave and to take their money. Believers in Adam Smith win, and believers in Thomas Aquinas lose.
First, let us examine another technical pattern, the symmetrical triangle. There is a symmetrical triangle which formed in gold back in 2006-07. This pattern explains the nice run-up of Sept. ’07 to March ’08 and is still influencing the gold market to this day.
A symmetrical triangle is a chart pattern in which successive swings moderate producing lower highs and higher lows. In the example above, point 1 is 5-12-06; point 2 is 10-6-06; point 3 (the lower high) is 4-27-07; and point 4 (the higher low) is 8-17-07. Before you can be sure you have a symmetrical triangle, you must be able to count points 1,2,3 and 4 as above, alternative highs and lows. No fair getting two highs in a row and then two lows in a row.
This pattern allows you to draw a descending line (connecting the two highs) and an ascending line (connecting the two lows. And these two lines, together with an imaginary vertical line to the left, form a triangle, hence the name. A symmetrical triangle is considered to be a consolidation pattern meaning that it is a time when the market consolidates in the middle of a larger move. Thus the pattern is more likely to break out in the same direction it was moving before the triangle formed. In this case, gold was moving up from the summer of 2005 to May 2006. Hence we expected a breakout to come to the upside. This breakout (penetration of the upper line) came on Sept. 7, 2007 and gold then proceeded to make a powerful move to the upside. Although volume is not shown on the chart above, any upside breakout must be confirmed by an increase in volume to be valid. Had the breakout been to the downside, it would not have been valid because it would contradict the fact that a triangle is a continuation formation. In this case, no inference could be drawn.
Like most technical patterns, the symmetrical triangle gives a minimum price objective. This tells how far (at least) the move will go. One takes the lower line (connecting points 2 and 4) and draws a parallel line through point 1. When the price hits this parallel line, this is the (minimum) price objective.
However, and this is important. any chart pattern, to be valid, must be drawn on a semi-log chart. What is a semi-log chart? It is a chart in which the Y axis (the vertical axis) is measured not in direct numbers but in the logarithm of the numbers. (A logarithm is an exponent.) For example, you may see a chart with the vertical scale numbered 10, 100 and 1000. When you measure the points, you find that the 10 point is 1 inch from the bottom; the 100 point is 2 inches from the bottom; and the 1000 point is 3 inches from the bottom. (1, 2 and 3 are the exponents one needs to raise 10 to to get 10, 100 and 1,000.) On a semi-log chart, the distance as the good moves from 100 to 1000 is just the same as when it moved from 10 to 100.
For goods which make only small moves, the difference between a semi-log chart and a regular (arithmetic) chart is too small to matter. But when you are talking about large scale moves in which prices double, quadruple or multiply by 10, then the semi-log chart is right, and the arithmetic chart is wrong. So for calculating price objectives, be sure to use the semi-log chart.
Semi-log charts are available for commodities on a continuation basis from www.timingcharts.com. Every commodity trades in given months (for example, June gold, August gold, December gold, etc.) A continuation chart plots the nearest month until it expires, then plots the new nearest month, etc.
The apex of a triangle is the point where the lower line (connecting the lows) crosses the upper line (connecting the highs). The apex for the symmetrical triangle above is $680. The price objective line for gold from the symmetrical triangle above crossed the $1,000 mark in March 2008. Gold hit this objective nicely, then declined precisely to its apex in October 2008 and began a dramatic rally through the remainder of the autumn and winter. This return to the apex is very common. It is not an absolute requirement, but it happens the overwhelming majority of the time. (It usually begins shortly after you have given up hope.)
If we think back to Thomas Aquinas’ theory of the fair price and remember that most such people identify the fair price as the price when they were watching the good or the price they traded at, then the apex of the triangle identifies what the public thinks of as the fair price for the good. Since the long term price trend is up, as identified by the breakout, the return to the apex is the final return to what the public thinks of as the fair price. Adam Smith refuted the idea of a fair price arguing that the only price that was fair was that agreed upon by buyer and seller. The technical return to apex is the opportunity for followers of Adam Smith to buy this bullish good when the followers of Thomas Aquinas are selling.
Keep It Simple
Technical analysis mostly appeals to people with a mathematical background. I am a former math teacher and college math major. My mother was one of the great math teachers. However, it must be kept in mind just where and when mathematics is useful.
Certainly mathematics has proved useful in the physical sciences. If one plots the path of a cannon ball given an initial force and direction which is then countered by the force of gravity, the usefulness of mathematics is clear. The same is true for a cue ball in pool imparting its motion to other balls depending on its angle and speed.
However, cannon balls and cue balls are physical objects. They do not have free will. In market analysis, we are not dealing with physical objects. If the cannon ball says, in mid-flight, “I defy the law of gravity; I think I will soar into the heavens,” then the physicist can safely reply, “You will obey my laws. No back talk.”
But the entities which act in the markets are other human beings. They are intelligent. They have free will. And they just might be as smart as you. If the economist says, “You will obey my law (meaning the law of supply and demand)”, then the market actor can say “I defy the law of supply and demand. The law of supply and demand says I must raise prices, but I am going to lower prices because I have compassion for the consumer.” And because the market actor has free will, while the cannonball does not, he has the power to do this. So we must conclude that market analysis is not the same as physics and does not have the same certainty attached to it.
Fortunately for the science of economics there is a higher law which applies to the defiant market actor. He has the power to ignore the law of supply and demand. But if he (in this case) sells for too low a price, then his business will turn from profit to loss. If he does not change his policy and obey the law of supply and demand, then the law of supply and demand will wipe him out of business. Yes, he is a human being, and he has free will. He has the right to be stupid, but he does not have the right to escape the consequences of that stupidity. In the long run, the law of supply and demand will win out. This is why Adam Smith laid it down as a principle that economic laws did not apply in the same sense as the laws of physics and chemistry. They simply tended closer and closer to truth as time went by. Keynes tried to counter Smith by saying, “In the long run we are all dead.” Well, today is the long run, and Keynes is dead The countries whose leaders took his advice are getting poorer. QED.
The importance of this is that many analysts who use technical analysis are over-trained in mathematics. They willy-nilly use the techniques they were taught in math class. They like to show off how smart they are. But many of these techniques made their way into mathematics because they worked in the physical sciences. They just do not work when the entity we are trying to analyze has free will and is potentially as smart as we are. After all, we are trying to take his money, but he just might not lie still for this and may figure out a way to double cross us and take our money instead.
To take his money, we must catch him in some mistake. We must see reality as it is while he makes an error. Above I have pointed out how very large numbers of traders accept the theory of the fair price, which was promoted by Thomas Aquinas. Under certain market conditions this mistake manifests itself in certain patterns and market behavior. If we learn to recognize these patterns, then we have the advantage. It is possible that the other traders may get smart. But they have been dumb for some 800 years; so it is not likely that they will all get smart tomorrow. This is why these patterns keep working in many different markets, year after year.
For example, above is a semi-log chart of gold (closing price)). Notice the nice uptrend line which has guided the entire advance since 2001. When a good has a strong fundamental force pushing it up, the first reaction by most traders is to think, “It is above its fair price.” So they move to sell. Then more fundamental buying comes in and carries it to a new high. They think, “Now it is really above its fair price.” This process continues on and on. Always the believers in the fallacy of the fair price are behind the trend. Thus the good takes much longer to reach its (fundamental) price objective than it would if people were perfectly rational. For this reason, the good technician will jump on a trend as soon as he has identified it, and then he will stay with it until it clearly reverses. The trend is your friend. The fallacy of the fair price slows down the trend and causes it to unfold over many years.
This is an example of the approach to technical analysis that I use at the One-handed Economist ($300/year). I also use Austrian theory economics (the ideas of Ludwig von Mises and Murray Rothbard, etc.) to analyze the economy. And this is further supplemented with the principle of the commodity pendulum. Taken together these are 3 powerful tools for predicting the markets. You might also wish to get an idea of my thinking by visiting my web site, www.thegoldbug.net (no charge). Here I blog on political and social issues from an economist’s point o view. Some weeks ago I did a job on homosexuals. This week I attack drinkers. If you can’t take criticism, this blog is not recommended.
I was a gold bug in the 1970s and turned long term bullish on gold once again in 2002. But in the ‘80s and ‘90s I took a breather from gold and became a stock bug. I try to see reality as it is, which often offends many people but does wonders for my record picking stocks and commodities. If you had $100,000 to invest on Jan. 1, 2000 and had a choice between the average U.S. stock mutual fund and my Model Conservative Portfolio, then I beat the average fund by almost 2:1. Thank you for your interest.
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-- Posted Monday, 11 May 2009 | Digg This Article | Source: GoldSeek.com
