Category Archives: Pattern Recognition

The 10-2 Year Treasury Yield Spread Continues to Indicate a Warning of a Possible Recession

March 7, 2022 By in Absolute Return, Asymmetric Observation, Global Directional Trends, Global Macro, Pattern Recognition, Systematic Global Macro

In Following the Trend of Inflation and Risk of Bonds I mentioned we are closely monitoring the 10-2 Year Treasury Yield Spread because an inverted yield curve has a track record of predicting future recessions 6 – 24 months in advance.

The 10-2 Year Treasury Yield Spread is declining fast and has now trended to 0.24%, meaning the 2 Year U.S. Treasury Yield is nearly the same yield as the Year 10 U.S. Treasury Yield.

For more context, read: How We’ll Know if a Recession is Imminent.

For information about our proactive investment management, active risk management, hedging your risks, and ASYMMETRY® Managed Portfolios, contact us.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is subject to change. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect a position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.

Your technical analysis is no match for Trump Tweets!

August 21, 2019 By in Artificial Intelligence, Asymmetric Observation, Data Driven Rearch, Data Science, Machine Learning, Pattern Recognition, Quantitative Evidence-Based Rearch, Technical Analysis, Trend Following Leave a comment

Someone texted me this image this morning.

Trump Tweets market reaction to trump tweet

Now that’s funny right there; I don’t care who you are!

But seriously though, many people like to blame others for their reality. Most of the time, the market does what it does, and something or someone always gets the blame for it – besides them.

It’s an easy way for them to be right. It wasn’t them and their risk exposure that was wrong, it was someone else like the President, or the Fed, or the machines.

I ignore the nonsense and focus on price trends. I focus on the facts.

Yes, I call it technical analysis of price trends, as it has been called for decades.

But, just like we are now seeing trading firms call computerized quantitative trading systems more trendy names like “artificial intelligence” and “machine learning” or “pattern recognition”, others have renamed technical analysis “quantitative analysis”

The trend seems to be driven by those who write research papers, books, and such.

To be sure, an example is a disclosure I saw in an SEC Form ADV registration document. In Methods of Analysis, Investment Strategies, and Risk of Investment Loss, the first lists: Quantitative analysis and Fundamental analysis, but not Technical analysis. I’m going to fictitiously call this firm “QUANT”.

QUANT will primarily utilize Quantitative analysis but may also use other analysis methods, including Fundamental analysis as needed.

Quantitative analysis involves the analysis of past market data; primarily price and volume.

Fundamental analysis involves the analysis of financial statements, the general financial health of companies, and/or the analysis of management or competitive advantages.

Investment Strategies QUANT will utilize long term trading and short term trading strategies.

Under Material Risks Involved, it goes on to say:

Methods of Analysis

Quantitative analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets do not always follow patterns and relying solely on this method may not work long term.

Fundamental analysis (I’m skipping this irrelevant part for brevity)

Investment Strategies

Long term trading is designed to capture market rates of both return and risk. Frequent trading, when done, can affect investment performance, particularly through increased brokerage and other transaction costs and taxes.

Short term trading generally holds greater risk and clients should be aware that there is a material risk of loss using any of those strategies.

Investing in securities involves a risk of loss clients should be prepared to bear.

What’s the big deal?

It isn’t a big deal, but, let’s change a single word to see what happens.

Let’s replace “Quantitative” with “Technical” and see if it fits the same.

Technical analysis attempts to predict a future stock price or direction based on market trends. The assumption is that the market follows discernible patterns and if these patterns can be identified then a prediction can be made. The risk is that markets do not always follow patterns and relying solely on this method may not work long term.

Yes, that’s the definition used for Technical analysis.

The point is, they just didn’t want to call it “Technical analysis” because “Quantitative analysis is more trendy in modern times.

But, it’s the same.

I don’t debate others hoping to change their minds, but instead, I do mull over what others believe to see how it may be in conflict with what I believe. By doing that, it allows me to question my own beliefs to see if there is enough evidence to change what I believe. I do that to combat what we are all more prone to do, which is seek out information that confirms what we already believe and ignore information that says it isn’t true. Humans have the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. If we want to gain new knowledge, we have to consider we may be wrong and apply a scientific approach to discover new knowledge.

Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that affirms one’s prior beliefs or hypotheses. It is a type of cognitive bias and a systematic error of inductive reasoning.

We have to be careful of looking for information that reinforces what we already believe, without considering what could be wrong about our beliefs.

It’s reverse-engineering.

I try to break it to see if it will break and what makes it break.

…and speaking of Technical Analysis, Long Term U.S. Treasury Bond ETF TLT has been in a volatility expansion, on the upside. Demand has driven its price momentum up to levels historically seen during larger stock market declines. The price is now outside the upper price channel. You can probably observe what it typically does afterward.

technical analysis of TLT $TLT trend following

Technical Analysis of the S&P 500 index price trend: it looks to me like we’re about to observe a breakout in one direction or the other. The last time, in May, the breakout was to the downside. This time may be different. See the first image above for risk disclosure of what may go wrong — or at least who may be blamed for it 🙂

technical analysis of the stock market spx

Technical Analysis of VIX: the volatility expansion has now contracted from 25 to 15. So, the options market now expects the range to be within 15% instead of 25%.

We’ll see if vol expectations continue to drift down, or spike back up.

Ps. I didn’t provide any evidence of my political beliefs. If anyone took anything from the above as a sway one way of the other, they are joking themselves as I am joking with them. I focus on the facts. We can’t blame any single thing or any one person on the direction of stock market trends and if anyone does so, they are joking themselves.

We can say the same for calling Technical analysis Quantitative analysis, believing by changing the word, it means something different.

It doesn’t.

I say believe and do whatever creates asymmetric investment returns for you.

But as Larry the Cable Guy says:

Now that’s funny right there; I don’t care who you are!

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

Mike Shell and Shell Capital Management, LLC is a registered investment advisor and provides investment advice and portfolio management exclusively to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as advice to buy or sell any security. Securities reflected are not intended to represent any client holdings or any recommendations made by the firm. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data is deemed reliable, but is not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

Pattern Recognition: Is the S&P 500 Forming a Head and Shoulders Bottom?

November 13, 2018 By in Active Risk Management, Asymmetric Observation, Asymmetric Risk Reward, Global Directional Trends, Pattern Recognition, tactical risk management, Trend Following, U.S. Stock Market 1 Comment

I don’t always share when I observe stock market patterns unfold, but when I do, it’s usually to inform (or aggravate) my friends who don’t understand (or want to understand) technical analysis.

Long before I started developing computerized trading systems based on quantitative signals I learned and applied chart patterns and trend lines to determine if a trend was up, down, or sideways. Said another way, up until 15 years ago I identified the direction of price trends visually looking at a price trend on a chart. I later defined up, down, and sideways with mathematical equations that help to systematize the process of trend identification. I believe my starting out learning trends by hand and visual representation helped me to develop better quantitative trend systems. The two go hand in hand.

We can define the direction of a trend with an equation as simple as momentum. For example, I have 14 different definitions of momentum and equations that define it. A simple one is X period rate of change. If it’s positive, the trend is up. If it’s negative, the trend is down. The factor that determines the trend direction is the time frame. Many academic types like using simple time series momentum methods like this because it’s easy to backtest. Pattern recognition is more difficult, so fewer have developed systems to automate pattern recognition and make it testable.

Chart patterns have historically been more visual. Chartists or technical analysts look at the chart of a price trend to determine if there is a pattern. The pattern we are looking for tells the story of supply and demand. The chart of a price trend shows us what has been going on with the battle between supply and demand from buyers and sellers. We may get an idea of who may be winning the battle and position our capital in that direction. For example, when prices are rising the buyers are in control and when prices all falling selling pressure is dominant. So, pattern recognition is just another form of trend following. Instead of using X-day breakouts, moving average, or channel breakouts, it’s using a pattern that is believed to tell the story of price action. We don’t make decisions based on a pattern, but the underlying asymmetry between buyers and sellers that caused the pattern and the direction of the price trend.

Simple > Complex

To me, it’s a much more simple way to determine if buyers or sellers are in control of the price trend than trying to find a fundamental narrative. There are so many different reasons for buying demand and selling pressure we could never really know why one is dominating the other. The news attempts to explain it, but the truth is, investors could be buying or selling based on perceived fundamentals, trend lines, moving averages, stop losses, buy stops, fear of missing out, fear of losing money, or tax reasons. Rather than trying to figure out what the majority is thinking, the pattern of the price trend tells the net result of all the buying and selling. It fits the idea of simple beats complex and if we simply stay with the direction of the trend we can’t be too wrong for too long. Someone making decisions based on things other than the price trend itself has the potential to stray far away from the reality of the price.

To me, chart patterns are really just a little more elaborate versions of trend lines. A trend line is just a line marking a chart such as how I marked the higher highs and higher lows yesterday in Divergence in the Advance-Decline Line May be Bullish. 

I observed today the S&P 500 seems to be forming a head and shoulders bottom pattern. The head and shoulders pattern happens when a market trend is in the process of reversal either from a bullish or bearish trend.  There are two kinds of head and shoulders.

  • A head and shoulders top is a pattern that forms after an uptrend. After it is completed, it signals a reversal of the trend from up to down.
  • A head and shoulders bottom is an inverse of the head and shoulders top. The head and shoulders bottom forms after a downtrend and signals a change of trend from down to up.

Below is the chart of a theoretical index used to represent an idealized head and shoulders. It includes both head and shoulders tops and head and shoulders bottoms. Stockcharts offers this index for educational purposes to see what idealized head and shoulders look like. You may notice each top and bottom are a little different – they aren’t perfect.

head and shoulders pattern recognition

I put the green box around a head and shoulders bottom. You can see why when you look at the S&P 500 stock index chart below.

head and shoulders bottom patterns recognition

An inverse head and shoulders pattern is simply a downtrend caused by selling pressure, interrupted by a brief reversal (left shoulder), a selling climax (head), an interruption again (right shoulder), then it would move on to new highs. Moving on to new highs will determine if it is completed as a reversal bottom, or not. To reverse the downtrend, selling pressure must be exhausted as buying demand becomes dominant.

Many patterns like the head and shoulders rely on volume as confirmation, so chartists can make it as complicated as they want, or keep it simple by looking at the pattern. For my purpose, I’m going to keep it simple and say we’ll know if this is indeed a head and shoulders bottom reversal pattern if it follows through on the upside. If it does, we would expect the price trend of this index to at least reach its old highs. If the price doesn’t hold and it doesn’t follow through to the upside, it’s probably going to at least test the prior low again.

Either way, patterns are never completely accurate. It’s probabilistic, never a sure thing. The head and shoulders is simply a pattern formation commonly seen after a downtrend that, if completed, may signal the end of the downtrend and reversal into a new uptrend. It’s based on the visual representation of the battle between supply (selling pressure) and demand (buying interest). For example, when the head and shoulders bottom completes the low point in the (inverse) head, it marks the point when those who wanted to sell have sold. So, the right (inverse) shoulder signals selling has dried up and buyers are taking over. It is completely normal to observe profit-taking after an advance, so the last few days is normal even if this is a reversal up. You can probably see how volume gets involved to confirm the pattern. In the case recently, the volume was high at the lows signaling selling pressure. The volume is declining on the right shoulder. The good news is, the volume didn’t expand on these recent down days.

Let’s see how it all unfolds.

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

The observations shared on this website are for general information only and are not specific advice, research, or buy or sell recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. Use of this website is subject to its terms and conditions.

 

Front-running S&P 500 Resistance

July 26, 2018 By in Asymmetric Information, Asymmetric Insight, Asymmetric Investment Returns, Asymmetric Observation, Asymmetric Risk Reward, Asymmetric Thinking, Counter trend, Critical Thinking, Global Directional Trends, Independent Thinking, Information Asymmetry, Pattern Recognition, Quantitative Evidence-Based Rearch, Technical Analysis, Trend Following 1 Comment

The S&P 500 stock index closed just -1% from its all-time high it reached on January 26, 2018, and hasn’t been that high since. It’s been in a drawdown that was as much as -10% and it has taken six months to get back near its high point to break even.

SPY SPX $SPX $SPY S&P 500 STOCK INDEX

Before the madness begins saying “The S&P 500 is at resistance,” I want to point out an observation of the truth. It is one thing to draw a trend line on an index to indicate its direction, quite another to speak of “support” and “resistance” at those levels.

Is the S&P 500 at resistance? 

Depending on which stock charting service or data provider you use, it may appear the S&P 500 ETF (SPY) closed at its prior high. Many market technicians would draw a line like I did below in green and say “the S&P 500 is at resistance.”

S&P 500 stock index at resitance SPY SPX

In technical analysis applied to stock market trends, support and resistance is a concept that the movement of the price of a security will tend to stop and reverse at certain predetermined price levels.

Support is when a price trends down and stalls at a prior low. The reasoning is that investors and traders who didn’t buy the low before (or wish they’d bought more) may have buying interest at that prior low price if it reaches it again.

Resistance is when a price trends up and stalls at a prior high. The reasoning is that investors and traders who didn’t sell the high before (or wish they’d sold short to profit from a price decline) may have the desire to sell at that prior high price if it reaches it again.

Whether everyone trades this way or not, enough may that it becomes a self-fulling prophecy. I believe it works this way on stocks and other securities or markets driven by supply and demand, but an index of stocks?

To assume a market or stock will have support or resistance at some price level (or a derivative of price like a moving average) that hasn’t been reached yet is just a predictive assumption. Support and resistance don’t exist unless it is, which is only known after the fact.

One of the most fascinating logical inconsistencies I see by some technical analysts is the assumption that “support” from buying interest and “resistance” from selling pressure “is” there, already exists, before a price is even reached. Like “SPY will have resistance at $292.” We simply don’t know until the price does indeed reverse after that point is reached.

But, it gets worse.

To believe an index of 500 stocks is hindered by selling pressure at a certain price requires one to believe the price trend is controlled by the index instead of the 500 stocks in it.

Think about that for a moment. Let it sink in. 

  • Do you believe trading the stock index drives the 500 stocks inside the index?

or

  • Do you believe the 500 stocks in the index drive the price of the index?

What you believe is true for you. But, to believe an index of 500 stocks is hindered by selling pressure or buying interest at a certain price requires you believe the price trend is controlled by the index instead of the 500 stocks in it. That’s a significant belief.

To complicate it more. If we want to know the truth, we have to look a little closer.

Is the S&P 500 at resistance? 

As I said, it depends on which stock charting service or data provider we use and how we calculate the data to draw the chart. Recall in the prior chart, I used the SPDRs S&P 500 ETF (SPY) which shows the ETF closed near its prior high. I used Stockcharts.com as the data provider to draw the chart. I’ve been a subscriber of their charting program for 14 years so I can tell you the chart is based on Total Return as the default. That means it includes dividends. But, when we draw the same chart using the S&P 500 index ($SPX) it’s based on the price trend. Below is what a difference that makes. The index isn’t yet at the prior high, the SPY ETF is because the charting service includes dividends.

SPY SPX TOTAL RETURN RESISTANCE

Here is another charting service where I’m showing the S&P 500 ETF (SPY) price return, total return, and the S&P 500 stock index. Only one is at the January high.

spy spx S&P 500 resistance

So, we don’t know if the S&P 500 is at resistance and we won’t know if there exists any “resistance” there at all unless the price does pause and reverse down. It so happens, it just may pause and reverse at this point. Not because more tactical traders are looking at the total return chart of SPY or because the index or ETF drives the 500 stocks in it, but because momentum measures indicate its potentially reaching an “overbought” level. So, a pause or reversal, at least some, temporarily, would be reasonable.

Some may call this charting, others call it technical analysis, statistical analysis, or quantitative analysis. We could even say there is some behavioral finance included since it involves investor behavior and biases like anchoring. Whatever we choose to call it, it’s a visual representation of supply and demand and like most things, it’s based on what we believe to be true.

I’ve been applying charting, pattern recognition, technical analysis, statistical analysis, and quantitative analysis for over twenty years. Before I started developing computerized programs based on quantitative trend systems that apply evidence-based scientific methods, I was able to trade successfully using visual charts. I believe all of it has its usefulness. I’m neither anti-quant or anti-charting. I use both, but for different reasons. I can argue for and against both because neither is perfect. But, combining the skills together has made all the difference for me.

Is the S&P 500 at resistance? 

We’ll see…

 

Mike Shell is the Founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Global Tactical.

You can follow ASYMMETRY® Observations by click on on “Get Updates by Email” on the top right or follow us on Twitter.

The observations shared in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risk including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results.