Thursday, April 03, 2008

Caution for technical traders

The new SFO is out. Check it out at for access and a free subscription.
The issue includes an article by Darin Newsom -"The Electronic Age of Trading", and although Darin's focus is the futures market, his comments resonate across all markets as he stresses the importance of following momentum. Below is an excerpt:
Technical Traders Beware
Another casualty of this new era of electronic trading is old technical signals. Computers, and to some degree the engineers who develop the formulas, are not driven by emotion, so formations on a chart mean nothing to them. Orders are placed at prices determined by algorithms, taking into account such things as market value, return on investment, and possibly, independently derived supply and demand projections. Support and resistance lines mean little, as do moving averages, RSIs, and most of the rest of the multitude of technical indicators that have been tried and applied over the years. Therefore, the more complex these markets have become—noncommercially driven by electronic orders generated by intricate algorithms—the easier they have become to analyze. In the November 2007 issue of SFO, I wrote about applying Newton’s First Law of Motion to the markets. “An object in motion tends to stay in motion until acted upon by an outside force” can be translated to “A market in motion (trending) should remain in its trend until acted upon by an outside force (noncommercial traders change their mind).” That’s the best understanding we can gather at any one time about the market. If a particular market is rallying, investment money is buying. If the trend is down, this group is selling. Using the simple rule of not getting crossways with the trend means those wanting to take part in these markets should simply follow the trend and be prepared for a hair-raising ride.
Darin's analysis mirrors some of the suspicions which I have previously explored on this blog. My series last September 1st-7th looking at order flow defragmentation algorithms should have been a wake-up call that large traders and commercials are always finding new ways to disguise both their intent and actions in order to reduce front running and tailgating. Time and Sales data have become increasing difficult to decipher, although both the NASDAQ and the NYSE offer analytical tools (for a considerably fee) to help traders find transparency in order flow.
Although the 1-2 minute TICK has been a great daytrading leading indicator for many years, I suspect it will be the next casualty as algorithm developers pursue even more sophisticated means to shield their activity.

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