(Bloomberg) – If you’ve bailed out for Bollinger Bands, walked away from relative strength, or took the direction of the directional market indicator in 2021, you’ve paid for it.
It is evidence of the direct performance of stocks that virtually all of the signals telling investors to buy something other than to buy have done them a disservice this year. When applied to the S&P 500, 15 out of 22 map-based indicators collected by Bloomberg actually lost money, backtesting data shows. And all of them are worse off than a simple buy-and-hold strategy that’s up 11%.
Of course, few investors use technical studies in isolation, and even when they do, they seldom rely on a single charting technique to make decisions. But if anything, the exercise is a reminder of the futility of calling a market top in a year when the journey was essentially a one-way street.
“What we’ve seen this year is a very strong up market that hasn’t seen a lot of setbacks,” said Larry Williams, 78, inventor of the Williams% R indicator, which is designed to capture a shift in the momentum of a security. A long-short strategy based on this technique is down 7.8% since the end of December.
“All of the overbought and oversold indicators, both mine and others’, have not received many buy signals, they have received many sales,” he said.
The temptation to book profits and bail is hard to resist after the best 12-month rally in the S&P 500 since the 1930s. Rising fears are a mountain of charts that signal a market that is reaching its limits.
Earlier this month, the index rose 16% above its 200-day average, a performance that had happened only a few times in the past three decades prior to December. In addition, the benchmark’s relative strength index exceeded 70 both weekly and monthly, a sign that the market has risen too far and too quickly.
Add experts warning of bubble-like reviews and resurgent coronavirus concerns, and it’s a recipe for sell orders. For example, hedge funds hit the exits this month, removing from technology stocks just days before Apple Inc. and Amazon.com Inc. financial results were released.
However, avoiding the stock market for a period of time has proven to be the riskiest bet of all. The S&P 500 still has to save more than 5% this year. At the same time, it is more criminal than ever to miss the big days. Without the first five sessions, the index would grow by 11% to 2%.
“You could go to Las Vegas to guess that this is the right time not to be in the market,” said Mark Stoeckle, CEO of Adams Funds. “It’s just as risky.”
Bloomberg’s backtesting model buys the S&P 500 when an indicator signals a “buy” and holds it until a “sell” is generated. At this point the index is sold and a short position is built and held until a buy is triggered.
A strategy that follows RSI signals is down 10% this year. The damage came when stocks entered the year with unbridled momentum that sparked a sell order. Trading has taken place since then as the S&P 500 never pulled back quickly and long enough to make a flash purchase.
The convergence / divergence indicator for the moving average – better known as MACD – has taken a 9.8% loss. Five of the nine trading signals the model generated were purchases and four of them lost money. In addition, all four short referrals were losers.
That’s the cost of betting against the momentum in a market where the S&P 500 has already exceeded the year-end goal of the average Wall Street strategist.
“Today, and for much of 2020, the overbought conditions have been absorbed by the market with greater strength or, at best, a pause,” said Jeff deGraaf, co-founder of Renaissance Macro Research, named the best technical analyst in the Institutional Investor’s vintage survey for 11th consecutive years until 2015. “Overbought / oversold conditions are useless without first defining the underlying trend of the market.”
Williams, who has acted since 1962, agrees. Technical analysis tools aren’t broken, he says, but in a bull market as robust as this one, investors need to use them in the right context.
“You must have another tool, if you will, for a job you do,” he said. “I have a hammer that can build a house, but if I dig a hole in the ground with the hammer, it will be very difficult.”
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