Attention Frustrated Chartists: It ain’t HFT – it’s the Macro!

May 9, 2012

Roughly speaking, traders come in two classes: Those who use charts and those who don’t.

Within the charting community — especially among the practitioners of “pure” technical analysis, i.e. no fundamentals allowed — there is a new meme going around.

That meme is as follows: High Frequency Trading (HFT) has ruined the markets.

Thanks to those damn robots and their wicked brutalization of support and resistance levels, this meme says, it’s just hard for a chart trader to make a buck anymore.

It’s a frustrated rallying cry — and an effort to place blame. You can almost picture the laid off mill worker slumped heavily at the bar, muttering into his beer… the machines — damn those machines

This meme was crystallized for me by Mike Harris of Price Action Lab (whom I had never heard of, but discovered via Josh Brown).

Here is the Harris dramatization of the situation at large:

Surrounded by robots he knew the end was near. One chartist against 1,000 HFT robots. One man trying to predict the future against 1,000 robots that create the future. He pulled out his last chart and he looked at it again a few times. He had to be right this time around in the name of all chartists who have fallen in the line of duty. He opened the chart analysis book written in 1929 and he looked at the pattern in the stock of Horse Food Packers International. The book said that this is a bearish pattern. This looked identical to the current pattern in SPY. He made his call. He knew that this was his last chance.

There are still a few around that refuse to give up but again most got nothing to lose. Chart analysis alone is a doomed activity. Chart analysis can be helpful in providing a context for evaluating the significance of signals obtained from algorithms that measure probabilities of directional price moves based on the analysis of price, volume and time. But charts alone are mere illusions…

– The Last Chartist (Price Action Lab)

Okay. As someone who cut his teeth using charts, I’m going to be blunt here: This sounds like whiny bullshit to me.

(And by the way, who’s trying to predict the future? The game is odds and probabilities, not prediction — but I digress…)

The following are my comments in the TRB discussion thread of the Mike Harris piece — views I shall expand on momentarily:

As a counter one could argue that blaming HFT is just a new version of sour grapes, i.e. “the market is rigged” blah blah blah.

There are plenty of alternative explanations for why markets have been so tough for traders as of late — for one big thing, the “head in a mixer” back-and-forth dynamic between bullishness off Federal Reserve stimulus and bearishness off the ongoing risks of eurozone crisis and China implosion / global slowdown.

The utter chaos of current top down conditions is further bolstered by the poor performance of top notch hedge funds who don’t use technical analysis as a general rule: Quantum Fund lost 15% last year and Maverick Capital (Lee Ainslie’s fundamental driven long / short fund) lost 30%. Do you think they are blaming the death of technical analysis too?

Anyone who points to the slamma jamma reversal action on a chart in this environment and then blames robots, rather than recognizing the extreme swings of investor sentiment these days caused by massively conflicting top down macro signals, is oblivious to the utterly confusing nature of the fundamental environment, and possibly blaming their failures on a proximate scapegoat (robots etc) without understanding what the real drivers are.

And yet, on the other hand, hey — the more traders who throw in the towel and give up the better. Properly applied strategies are more profitable when less followed.

And my second rejoinder in the same discussion thread, defending against the assertion that charts have become useless:

Agree that a lot of technical analysis is “voodoo,” pseudoscience, delusions in the eye of the beholder etcetera. But there are also reasons why well-designed non-HFT mechanical systems work, with explanations as to why they work.

As for what candlestick charts can and can’t do, I agree deeply with Kovner, paraphrase: “TA says nothing about the future; it tells you what other market participants have done up to the present. You have to use your own experience and judgment as to what happens next.”

There is a view of technical analysis that sees TA as a window of investigation for further possibilities; a sharply expanding range bar on significantly higher than average volume, for example, is not some kind of magical pattern but simply a clear indicator that something interesting is happening — like an arrow that points to potentially meaningful sea change in  investor sentiment and institutional capital flow.

Many so-called “patterns” fulfill this function; TA can effectively be viewed and used not as a standalone crystal ball, but as a highly compact and efficient represention of sentiment and capital flows, with flags of interest popping at the interesting intersection where shifts occur. This use of TA — in conjunction with a deeper understanding of what drives markets on a fundamental level — sits in too high a timeframe and too case-by-case an application set to be degraded by “bots” or other operators in the high frequency space.

But then, what I describe here is not really “true” TA in the first place, to the extent that true TA represents a slavish devotion to the idea that chart patterns actually have intrinsic meaning, instead of merely being two-dimensional abstract representations of aggregate buying and selling activity and nothing more.

“Okay then,” the frustrated chartist club responds.

“If high frequency trading hasn’t @$#ed up these markets, then what has? Because you can’t deny these markets have been screwy…”

To which I say yes, markets have been screwy, Daffy Duck screwy even, to the point of making chart traders — some, but not all — want to punch monitors and tear their hair out.

But as the title asserts, it ain’t HFT  I tell ya — it’s the macro!

As someone who looks at 300+ charts a day AND consumes the informational equivalent of half a dozen newspapers per day, I feel reasonably well qualified to pitch in my two cents on this.

To me, the Occam’s Razor explanation for why charts have gone Daffy Duck is not because of robots, but simply because the macro environment has been bizarre… like “unprecedented in history” bizarre. And it’s been this way for a while now.

This week’s trading action is a perfect example.

As I write this at my desk, trading screens flashing on my second monitor, the S&P is acting like a cartoon character on crack. It’s been that way all this week:

  • Monday was quiet, when a downside blowout on Greece was expected.
  • Then the downside blowout came on Tuesday — but it almost completely reversed, with an impressive clawback for the bulls.
  • Then today, Wednesday — a repeat of Tuesday’s wackiness! Nutty drop, nutty retracement… what gives? The robots run amok, right?

Nope. It fits the fundamentals. Click the chart for more legible text:

click to enlarge

How much you wanna bet this bizarro action continues?

Half the traders out there are remembering the lesson of Lehman Brothers, waiting for Europe to bust this sucker wide open, while the other half are recalling all the “Boy-Cried-Wolf” episodes where the eurozone drama du jour was resolved at last minute, leading to a melt-your-face-off risk-on rally, sung to the tune of “crisis over, everything’s super.”

With a backdrop like that, you don’t need robots to explain the “Mr. Market on drugs” phenomenon.

They say truth is stranger than fiction. As a long time practitioner of the global macro style, I can say I have never seen such “stranger than fiction” markets in my lifetime. And older generation trader friends with double my time in the saddle say something similar.

The macro is just nuts, ok? I mean everywhere you look, you run into some version of “irresistable force meets immovable object:”

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  • The debt-laden West is on an irresistable path toward economic reckoning and the need to “clear” excess leverage — yet the printing press enabled Federal Reserve is the immovable object opposing it.
  • The eurozone is caught between a ridiculously hawkish Germany (“we’re not budging”) and a ridiculously dead-in-the-water periphery problem (Spain, Greece et al = toast).
  • China — and by extension Australia — are headed for a massive property bubble / commodity / infrastructure bust, and yet the People’s Bank of China has the biggest war chest of all central banks with which to stave off the reckoning.
  • Serious inflation and serious deflation are both reasonably argued possibilities for “what’s next.” There are sharp guys arguing short treasurys are the trade of the decade and sharp guys backing up the truck / buying treasurys with both hands.
  • Now take all the above and consider that 1) America might actually recover (thanks to unexpected economic resilience and a housing bottom), but 2) America ALSO might be completely screwed (economically speaking, in the medium term, as a result of false housing bottom and bad-to-worse crisis response policies).
  • So… is it any wonder these markets are screwy?

One other point, re, screwy charts and where to place blame. In light of the above, consider this Stevie Cohen quote from Stock Market Wizards:

[Wharton] taught you that 40 percent of a stock’s price movement was due to the market, 30 percent to the sector, and only 30 percent to the stock itself, which is something that I believe is true. I don’t know if the percentages are exactly correct, but conceptually the idea makes sense.

If as much as 40% of a stock’s movement is due to “the market,” which now includes bizzaro top down factors whippy enough to make investors howl like cats in a dryer, how could charts not be Daffy Duck in this “risk on, risk off,” coming-and-going blenderfest?

The Longer it’s Bad, the Better it Gets

I’ll close this  — my 2 cents turned into two bucks — with a positive outlook.

From a macro perspective, these markets have been “bad” (i.e. hopelessly screwy) for a while. But the longer they stay bad, the better they’ll be in future… particularly for chart-based traders.

Why? Simple game theory:

  • These high-drama tensions will eventually clear, one way or the other. (Yes Virginia, the eurozone crisis will actually end some day.)
  • The longer this mess takes to clear, the fewer “survivors” there will be on the other side.
  • The fewer traders there are using a strategy, the more effective that strategy is likely to be (once the macro environment stabilizes).

So hey, wait a minute, what am I doing… I should be agreeing with the robot doomsayers.

Yeah, charts have gone bad forever — that’s the ticket… all of you should stop using charts immediately… throw in the towel, yeah… just kidding.

Chart debate aside, are there ways to still trade and prosper in this environment? Ways to preserve capital and make some decent coin too?

I say yes. It takes some adjustment, and a little bit of willingness to grind more than usual, but it’s definitely doable.

In a future piece we can talk about the successful “adjustment steps” Mercenary has taken to handle this persistent wackiness.

funny old world innit,


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16 Responses to Attention Frustrated Chartists: It ain’t HFT – it’s the Macro!

  1. mikec74 on May 9, 2012 at 6:18 pm

    Interesting blog post (and just to note this blog is at the top of my must read list). Random thoughts/comments in no particular order

    1. As I recall you guys are big fans of Peter Brandt. Your post here almost seems like a direct rebuttal to this one……

    Is Peter totally off the mark here?

    • Jack Sparrow on May 10, 2012 at 12:34 am

      Peter is a close and dear friend — I don't think we are directly opposed so much as having 'adjacent perspectives.' The issues he talks about are real and meaningful; we have just adjusted to them in a slightly different way perhaps (to be expounded on in a future post)…

  2. mikec74 on May 9, 2012 at 6:18 pm

    2. For my longer-term investing, I am primarily a value-oriented asset allocator with just an overlay of technical analysis for risk management. For my shorter-term trading (mostly options, option credit spreads, and as of August 2011 futures) I mostly trade classical chart set-ups. The last few months have just been brutalizing with failed signal and reversal after another. Got chopped up to hell on corn, then bought the breakout of oil over 104, never achieved the target price and stopped out for a loss. Then U.S. bonds looked to be forming a giant top, and the breakdown of ZB at 138 I thought was the slam dunk of the year and went way too big to watch it stop and reverse at 138 and exit at 141. It just seems like there is no follow-through whatsoever on any breakout/breakdowns…just a few points and then a violent reversal. I think you are mostly right that it is just the perception of inflation versus deflation switching on a dime.

    • Jack Sparrow on May 10, 2012 at 12:38 am

      Not only that, but a good bit of this has been intentional on the part of the central banks — as a quick example, consider Ben Bernanke's verbal management of the $USD. The Fed watches the dollar, and knows how to whip and drive that market. What they want is a band in which the dollar does not get too weak (i.e. accelerate to downside collapse), but they don't want it getting too strong either. So they intentionally manage for a range… there are multiple examples like this, heavy handed government / CB involvement (US, Europe, China etc) intentionally trying to cut off the tails and keep things in the middle of the bell curve. When they finally fail, it's going to be spectactular. Meanwhile, traders have to be pinball wizards…

    • plyka on May 12, 2012 at 8:18 pm

      You could be right regarding options, option credit blah blah blah, but regarding futures trading and using "classical chart set-ups," i'm sorry but if by classical you mean things like breakouts/breakdowns, support/resistance, etc., i'm not sure if that's going to work. In fact, i would wager to bet that you would be far better off in the futures markets if you did the exact opposite of what "classical chart setups" tell you to do.

      In my opinion, the markets are all about FORCE. This is the most important advice i can give anyone about trading. FORCE/POWER is the key.

      • Jack Sparrow on May 15, 2012 at 12:28 pm

        The nice thing about markets is we can all wager as we see fit, and let P&L be the judge…

  3. mikec74 on May 9, 2012 at 6:18 pm

    3. Gold….ahhh. gold- you guys have been correctly bearish, and I am and have been a long-term bull based on fundamentals, but here we are now with that critical level of 1600 broken and the trendline off the 2008 low. I actually went short 1 contract of YG (trying to shrink size for risk management) at 1599. With this break, you'd think it would be a slam dunk for a couple hundred points down given the length of that previous trend….but given the conditions you describe it won't surprise me one bit if it bottoms at some technically meaningless level like 1585 and then bursts upward again forcing yet another loss on what looks like a crystal clear set up

    • Jack Sparrow on May 10, 2012 at 12:39 am

      Yep — in the words of Flavor Flav, 'Can't truss it"

  4. mikec74 on May 9, 2012 at 6:19 pm

    4. Which leads me to this..

    .Chart debate aside, are there ways to still trade and prosper in this environment? Ways to preserve capital and make some decent coin too?

    I say yes. It takes some adjustment, and a little bit of willingness to grind more than usual, but it’s definitely doable.

    In a future piece we can talk about the successful “adjustment steps”

    Would love to hear more on this. How do you make adjustments in this environment without getting chopped up to death on every failed signal and reversal. Seems like you take your 2-3 points and exit, but that seems counter to the dictum of "letting your winners run".

  5. PeterLBrandt on May 9, 2012 at 6:48 pm

    My dear friend Jack:

    Michael Harris is the REAL Daffy Duck. I notice that he has already obsessed over your post with at leat four comments.

    I hate to turn your discussion forum into a school yard scrap with Mr. Daffy — your web site has too much class for that.

    Mr Harris is a nut case. He has been a member of the sorprano boy's choir that has campaigned against classical charting for years. I am convinced of two things:

    First, I doubt that Mr. Harris has ever really been a consistently profitable trader. He thinks like an analyst, yet wants to criticize traders.
    Second, being right is what drives him.
    Third, (or I forgot, there was only supposed to be two points), he just doesn't undertand charting. He does not get the fact that charting is not about being right, but about providing assymetrical trades.

    Don't let the Daffy Ducks get you down.

    Peter Brandt

    P.S. If Mr. Daffy is willing to release his IRS records for the past ten years proving that he actually undertstands trading I will retract everything truthful I have ever said about him.

    • Jack Sparrow on May 10, 2012 at 12:42 am

      Thanks Peter — and agree: Those who want to predict should get jobs as CNBC pundits, and leave the trading to traders…

  6. plyka on May 12, 2012 at 2:48 am

    I don't believe in this HFT stuff AT ALL. However, just because the whiners reason is nonsense, doesn't mean that the reason given in this post is correct either. It comes off as, you have a problem, now you need to go find a reason for it, and it just so happened you came up with "macro stuff."

    The reality is that there is always SOME REASON for the markets to do something. I really don't believe the markets are at all crazier than they have been at least for the preceding decade. OF course they are different, but they are always different.

    I trade Gold and Oil, day trade oil and swing trade gold. I always stay away from the stock indices, they are the absolute worst to trade in my opinion. The reason they are so bad to trade is, and this is just a guess, it's not the price of 1 thing, it's the combined price of hundreds of separate and largely unrelated things. Thus they don't have any distinct personality to me, they are always acting crazy, sloppy and choppy.

    • Jack Sparrow on May 12, 2012 at 10:26 am

      Uh, no. We don’t have a “problem” as we have adjusted to this market environment without a problem. What was offered in the post was a diagnosis as to why markets are temporarily more confusing than normal, and why this condition is temporary, rather than the suggestion of a permanent sea change (which blaming HFT or the death of charts would otherwise imply).

      I started off replying to the other points in your comment, but then realized cleaning up the misconceptions and contradictions would take a mop and bucket, and so changed my mind. Good luck with gold and oil.

      • plyka on May 12, 2012 at 8:21 pm

        lol, no need to be insulting with your post. If you don't intend to waste time cleaning up the misconceptions then you probably shouldnt waste time on stating that you won't waste time on cleaning up the misconceptions, lol.

  7. Ian on January 17, 2013 at 5:05 am

    Interesting article. Yes the markets are screwy because of exceptional fundamentals but I think the point also needs to be made that this : cannot be discounted in any way for the changing nature of price signals and movements.

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