Sector Anaylsis, Fair Value, and Intermarket Analysis

[Soultrader 12]

Recently, I had an opportunity to talk with the head trader for a big investment bank. I thought I would share some insights.

 

The style of this trading team is 100% discretionary. The head trader's core methodology was market profile, which was very surprising for a Japanese trader trading equities. One of the things he mentioned was that it was impossible to predict stock prices. Price may decline or lift on no news. So why does price move? Fair value in the sense of value area. Simply put, buyers and sellers do not agree on price and will rotate price until it has found balance. Thus, market profile traders call higher/lower value placements a TREND.

 

Now, what I found particulary interesting was his style of trading. He barely used charts or even a market profile chart. He could visualize a MP chart just by glancing at a bar/candlestick chart. He was also more interested in analyzing different sectors. What stayed strong and what stayed weak? Also, the % loss/gain for stocks. He would track approx 700 stocks. His main interest was knowing how much % stocks in certain sectors were up/down compared to stocks in other sectors. From my understanding, he was measuring relative strength/weakness.

 

He was also a hardcore contrarion. For example, he mentioned how the public thought insurance companies would go bust with the incidents of 9-11 and Hurrican Catrina. Insurance stocks did plumment on news. However, these insurance companies must charge a higher rate after the incidents. Hence, leading to profitability. Therefore one of the things he watches for is to buy insurance stocks after an overreaction on bad news.

 

He also mixes alot of intermarket analysis which I had trouble following. He would watch markets in Chile to determine which stocks would get affected in Japan, etc...

 

Overall I found his methodology quite fascinating and advanced. It reminded me of mixture of Dalton, Livermore, and Murphy. One of the things I am interested in learning more about is intermarket analysis. Does any of you use it in your trading? Any resources that I can look into?

[notouch 10]

There are a few books around on sector rotation like this one Amazon.com: Sector Investing, 1996: Books: Sam Stovall

 

I can't say I've looked into it much but there are analysts on Bloomberg TV who have explained the theory nicely.

 

On the subject of value and Dalton did you notice how the recent "top" was almost identical to the one that Dalton explained in the seminar we attended a few weeks back? The migration of the POC was up for weeks then we had those few days of overlapping value which is a classic Dalton top, then a classic single-print selling tail then as soon as it went below value the markets went sharply down. I'm not saying we won't come back up but it was interesting to see because I've been using MP more as a longer term tool rather than just a day trading tool. Presumably they're all longer term traders in this investment bank?

[TheBramble 10]

Interesting insights Soul. Especially so given my current areas of research.

 

I'm using a derivation of MP where instead of just 'time at value' I'm using 'volume at value'. Time is a function of habit, even for traders, is somewhat less fluid than is the 'commitment to trade'. For instance, it costs nobody anything not to trade and a value can be maintained with no buying or selling, simply through inaction. What constitutes commitment is the proactive/reactive pressures which lead to actual trading, and the extent of that pressure as mirrored in the volume traded. It's looking like abetter match for my trading style than does vanilla MP. As for your trader’s ability to ‘see’ MP just by looking at candlesticks, that’s what first alerted me to the volume angle for MP. Looking at the 5 min volume-candles and the equivalent MP in a second window – I could ‘see’ what it was that was missing informationally from the standard MP.

 

Sector analysis is pretty much a part of standard Dow theory. What stays weak in a strong market or strong in a weak market. I’m less into the sectors than into different markets right now. How currencies and commodities relate to bonds and stocks for instance. Murphy’s work in that area is still the best and serves as my template.

 

This isn’t the first time we hear of pro traders being far more (totally?) discretionary then us TA types imagine. But then, the stats on pro traders success rates needs to be more fully qualified before we all head off down that path. Commissions and other related trading services still, AFAIAA count more to their bottom line than do their pure trading activities.

[notouch 10]

Is this the sort of thing you're looking at TheBramble? I find the Volume Profile superimposed on a candlestick chart very useful.

 

 

As for Murphy I'm definitely going to reread the sections of his book on sector analysis and intermarket analysis to see if I can find any new light. Anyone who follows the treasury and stock markets together can see the close relationship between the two.