Machines Have Taken Over the Financial Markets

The Giants won the Superbowl, supposedly a bullish development for stocks. But Greece and its unwillingness to give in to EU demands are keeping the market from rejoicing for the NFC victory. 

O.K., it's probably hokey, but it's a good headline, and you went on to the second line. Greece is toast, literally. They will never be able to pay back even the 30 cents on the dollar that is being thrown around as "the deal." And the markets know it. The markets have factored that in. And the markets know that Portugal, Spain, and France are also in trouble. But, all of this is old news. It doesn't mean that it's not important, especially in the long term. It just means that in the nanosecond time frames used by high frequency traders featuring "Hal" and his brethren, it's not something to worry about for the next five or ten minutes, or in their view, an eternity. 

That's our world right now. One of fractals, and Chaos, and wonder over the flight patterns of starlings and the meaning of their "complex" flight patterns. We recommend a nifty article by Cris Sheridan, "Markets, Murmurations, and Machines" on Financial Sense on what it all means. Our take, and one that we have put forth before, is that machines are taking over the world. And trading is just another place where this phenomenon is obvious. What Sheridan's article does, is bridge the gap between the future and the present. It brings in the connection between quantum physics and real life into a new realm, that of trading stocks. 

When he writes that the intricate flight of the starlings "represents a steadily growing dynamic at work within our own society and financial markets—namely, the collective behavior of any highly interconnected system," he's writing of the connection between, Chaos, Disorder, and Complexity, the physics that rule the Universe. Indeed, he notes: "there may be no better way of capturing the mysterious behavior of complex systems than the unpredictable and yet highly coordinated movements of a thousand or so starlings flying in mid-air." In fact, the flight of the starlings isn't just unpredictable but predictably unpredictable, which is the basic tenet of Chaos theory, the basic premise of quantum physics, which is the physics that operates at the particle level. We are now living in a market governed by The Heisenberg Principle where matter is light and where if you know where a particle is you can't tell its speed or direction. 

What Sheridan means is that we are in a world where the direction of the markets is out of the hands of traditional investors who look at the fundamentals of any stock, or the economy. That stuff still matters at the human level. But that's not what ultimately moves the markets anymore. What moves the markets is that weird interaction between atoms, electrons, and particles of light in microprocessors, CPUs, fiberoptic pipes and the minds of the programmers who give the machines instructions. 

The market is out of our hands. And we are powerless to do anything about it, except to follow the charts, allowing for the fact that they are only as good as the speed with which they capture the activity of the machines. 

So where does that put us this morning? First, if you're using a seasonal trading system, two things are happening. One is that the turn of the month positive seasonality ends this afternoon. Second, is that January is gone and February is here. January is a positive seasonal month, while February often is a transitional or down month. This stuff still works, which means that if you have some profits, it makes sense to see if taking some money off the table makes sense. 

Second, Friday's response to the jobs number was a little over the top. This was more evident in the inside workings of the market than in the indexes, to some degree. 

Chart Courtesy of StockCharts.com

The S & P 500 rallied to a new high, but stopped short of 1345, a key resistance level. This kind of thing happens too often now to be the work of humans. Machines are clearly involved now, following programs to the letter of the instructions. Support and resistance levels are much too reliable compared to past decades where they were guidelines instead of gospel.

Chart Courtesy of StockCharts.com

The Russell 2000 (RUT) index of small stocks also made a new high. But RUT closed well outside of its upper Bollinger Band. That means that it has climbed too high too fast and it has to revert to its mean, which is the 20-day moving average. It can revert to the means by stalling and moving sideways or by falling back toward the mean, which means that a move back toward the 800 area or below is likely. If it falls hard enough, it could break key support and deliver a full blown correction. Only the machines and their programmers know what will happen. And it will only happen to the degree that other machines and programmers decide with their own programs. The one thing that is certain is that the small stocks are now very overbought. 

Chart Courtesy of StockCharts.com

The Nasdaq Advance Decline line (NAAD) made another new high. This is a positive as it means that more stocks are moving higher than those falling. This indicator could remain in an up trend, even if the indexes correct. That would be very bullish. We'll see. 

Chart Courtesy of StockCharts.com

The Nasdaq Hi-Lo line (NAHL) is now going straight up. That's worrisome as it suggests that there is too much upward momentum and that the market could be getting close to exhaustion. This is cautionary. 

Conclusion

Greece could default. But the markets are taking it in stride. That's likely because high frequency traders are too busy pushing prices higher with their algorithms. 

Small stocks seem to have come too far too fast. And upward momentum may be close to exhaustion. February is not as good a month as January usually. Bottom line. Be careful. Monitor each position carefully. If it's working keep it. If it's not, consider taking profits. 

When you understand the big picture, the next step is how to survive and profit from what lies ahead. That's why we recommend: "Market Timing For Dummies." and "Trading Futures For Dummies." The Trading Manuals for All Seasons. Also Available As Kindle Books.