8. April 2018
"Should I buy now?"
Stories about impatient Neanderthals
What are the most frequently asked questions about Technical Analysis? I’ll give you the top 5 question I get during my speeches and courses on technical and fundamental analysis. I have already gone through question no. 3, 4 and 5, so here goes no. 2: “Should I buy now?”
When I am giving a lecture, I often invite people to ask for a particular commodity or instrument. The idea is to go through the analysis on something that they are very familiar with. That way they can compare all the buy/sell signals to what they have done themselves throughout time. So it is when we go through their particular instrument that they say: “What does the technical analysis say now? Should I buy now?”
A few of these question are based on impatience. They don’t really want to know about the methods, just the result. A kind of “I don’t care about the analysis, I just want to get a clear recommendation that I can act on, and that way I benefit”. So that is the age-old thing of whether to give a fish (so they don’t starve today) or whether to teach them how to fish (so they can feed themselves in the future). There are a few of this “fish today” kind of people, but fortunately not so many.
The reason why I think this question is important has to do with a misconception about technical analysis. I mean the question is seemingly straight forward: “What does the technical analysis say today - should I buy?” The misconception is that you go in at any given day and get a buy/sell signal. The same people can ask me three days later “So what does it say today?”. Nothing has happened in those three days, and there are no new signals. So there is a misconception here, and that leads me to a very important distinction between “Signal value” and “General value”.
When you ask for a buy/sell signal, you are looking for a specific point. Often it is a price break above the moving average. Or it is a break above a well-defined trendline, or an RSI level. In any case, we are looking for a specific signal. A break above the moving average is what you traditionally think of as a “buy signal” in technical analysis. But how often do we get a buy signal? Very infrequent. A break above the long moving average is often followed by an uptrend of 1-3 years. So you won’t get a break below the moving average in the next 1-3 years (I’m not counting false signals etc). Even if you go to the daily chart, then a break below the moving average is often followed with 3-6 months of trend. So you won’t get a new signal in that time.
So you see the problem when people assume there is a buy or sell signal every day? Even on the short term, if we had a break below the moving average 1-2 months ago, there is still perhaps 1-4 months of time to pass before we get a new break above the moving average. So there is simply not many buy/sell signals. And that is precisely the strength of technical analysis. If you had a new buy signal every week, then you would not have a “lasting trend”. The strength is that a buy signal means that you get in, and the trend will last months (or years, if you have a buy signal in the monthly chart).
When I tell people this, they get it. They understand how long the price trend continues and they understand the buy and sell signals. They get it. But then they have that final question that makes me throw my arms up in the air: “Okay, I understand this. But the last buy signal came 2 months ago, and I didn’t know about this type of analysis then, so I didn’t buy anything. Now we have seen 2 months of increase, so what does the technical analysis say today? Should I buy now?”.
You see the predicament? They understand the concept, and they realize they have a system that they can use for the rest of their lives, if they just follow it. Great stuff. But then the short-term nature of them always pop up, and want the “fish today”. We are simply not a very strategic humanoid creature in general. We can have flashes of strategic thinking - but only until we are hungry, and then our impatient Neanderthal in us is reaching for the baseball bat and just wants to club something - preferably NOW.
At this point you may very well be protesting. Your point is that even though we had a buy signal 2 months ago, both fundamental and technical analysis can give us an idea how much more prices will have to increase before hitting the top. And yes, you are right. We can do the analysis and get an idea of “how much more” the increase can continue before hitting a turning point. But there are some problems with this way of thinking.
The first problem is that now we are not dealing with a “signal”. The signal came 2 months ago with the break above the moving average. So when you ask me today, we have to look at the RSI value to determine how much more the uptrend is going to last. Or you will use cycle analysis or Elliott wave analysis to give an idea. But the first problem is that neither of these gives you a “signal”. They give you a “general value” in understanding some of the nature of the current uptrend, but they don’t give you a concrete, tangible result (and that is what people often expect).
An example: The uptrend has lasted 2 months, and the RSI is now 76. What does that tell you? Hmm, not a lot. Often (but not always) the RSI needs to go to 85 before the top is in. But then sometimes the RSI hits 85 and create a divergence (falling RSI but increasing price). So even if the RSI was 85 today (which it is not, it is at 76), you don’t know if 85 is the top, or if the RSI is going to make 1 or 2 divergences before we reach the price top. Similar problems are found with the other types of analysis.
You DO get a lot of value and understanding out of the RSI and the other types of analysis. You can form a mental picture of what is “possibly laying ahead”, and you get more and more information as the RSI develops. This is really good and useful. But it is not a signal that says “NOW”. And that is what a person sitting in the audience wants. He simply wants to know “What is the analysis saying now, today”. There are no signals today. There is only a “general value” in understanding that the uptrend started 2 months ago (where he didn’t buy anything), and that the uptrend is likely to continue a little while longer - but we don’t really know for how long.
Maybe next month we will get a development in the RSI that allow us to get a better idea of how close we are to the top. But that is not today, not now. And that is why the guy in the audience is not impressed with this crack-pot type of analysis. He just wants to know whether he should buy today, and the analysis doesn’t give an answer. He is into the “fish today” mode, impatient. He has, on the other hand, not a clue that we are dealing with a method that will keep making him fish in the future. Not everyone is in the mode of “How can I learn to fish better”.
The real conclusion, naturally, is that we keep the position we started 2 months ago. Easy, right?! Those of us who paid attention to the proper way of fishing got the buy signal 2 months ago, and we bought. And today we keep the position. And we know that we will get many more sell and buy signals in the future, and we will follow them one by one. Both following the concrete “signals” and also following the “general value” so we understand more or less what phase we are in.
So that concludes the question no. 2 I often get. But how can I explain all of this to a group of people. Especially if they are in the “fish today” mode of thinking. It will take too muc time away from the topic at hand, and it requires a deeper understanding of the nature of the analysis. So I often try a very abbreviated version of the above, even though it is not fully satisfactory. But now I can just refer to this text. “Read this link where I have the answer to your question” :-)
One short comment about “pain” before I leave the topic. Where I work we have a common phrase where we describe a situation as “RSI 76”. That is a code, more or less like the police have codes “10-4” etc. You see, whenever people come with a commodity they need to analyze, in the majority of cases the RSI is already at 76. That means that there is already a lot of pain (I’m referring to a buyer where a high commodity price is a problem).
RSI 0-20 is “no pain at all, and we don’t think there will ever be pain again”. RSI 80-100 is “excruciating pain and it will never go away again”. So RSI 80 is problematic for the company and the budgets. Over the years I have found that people often come at RSI 76. They don’t come at RSI 20 because there is no problem (but it is precisely at RSI 20 the problems start). And they don’t come at RSI 80, because there the pain is already too much. So they usually come when the pain is starting to build strongly and that is roughly at RSI 76.
RSI 76 is a difficult place. They should have been buying a long time ago when the signal was there (but they don’t know this signal and so they didn’t buy). At RSI 76 the pain is high, but the end of the uptrend is already in sight. So we can still buy, but we are only removing the final top of the problem. So it is a difficult spot.
I have found that what motivates people to act is “pain”. That gets them going, trying to find someone to help with the problem. And whenever we get a request like that, 95 out of a 100 times the person is in a “fish today” mode. There is too much pain. So he only focus on the pain at hand - and doesn't have the capacity to focus on the future buy/sell signals that will get him out of the predicament he is in today. He is only focused on the pain today, and he wants an aspirin that makes the headache go away. And I’ve learned that in that pain mode there is no use in bringing the fishing gear on the table and explain how he can use these tools in the future.
So now you have listened very patiently to me. I’m impressed! But you just have one more question: “Should I buy now?”