What is Technical Analysis?
Technical analysis is a trading discipline that studies historical market data, including price and volume. It also uses insights from quantitative analysis to use past performance to predict future market behavior. The two most common forms of technical analysis are chart patterns and technical (statistical) indicators.
Our team in K&B uses Phil Erlanger Research software. This program focuses on delivering advanced technical and sentiment research data combining computational techniques with proprietary market data. This tool covers 8,000 equities, 24 sectors, and 153 groups.
Erlanger Chart Room Indicators
Erlanger Chart Room (ECR) is a statistical tool that helps us to reinforce our decision of entering, increasing, decreasing, or exiting a specific position (stock or ETF) and be smarter with your money.
“ECR offers several indicators and most of them fall under the category of bias, setups, and triggers. The purpose of looking indicators this way is to manage risk because potential risks are often ignored by investors and traders.”- Phil Erlanger
Erlanger’s methodology for trading is practical. First, you need to determine bias, then observe setups indicators and act on triggers to go short or long. Once you made the decision, you have to monitor the trade to hold or close the position.
The software has three types of indicators: Bias, Setup, and Trigger. We can imagine these three indicators as layers, and each one of them will support our trading decision.
Indicator 1: Bias
The search for the “Bias” is the answer to two simple questions: Should we buy or should we sell?
One of our favorite and indicators is the Displaced Moving Average or DMA Channel: A displaced moving average (DMA) is a normal moving average shifted to the right or left. It can be computed based upon a stock’s closing price, high price, and/or low price.
The DMA Channel in Erlanger involves averages of the high and low values of a time series. These averages form a channel that makes clear any trend change event, as well as the strength of a trend underway.
If a stock is trading above the yellow channel you should concentrate on long trades and when it’s below the channel on hedged/shorts positions, helping the portfolio manager to have discipline in their trading decisions.
Figure 1: Monthly DMA Channel on the SPY
Indicator 2: Setup
A setup indicates a potential change in trend working as a filter that steers the trader to moments when making a trade will result in greater success than others.
One of our favorite Setup indicators is the short ratio. The short ratio is a fast way to see how heavily short a stock may be. The ratio is also known as how many days are needed to cover all the shorts positions for a specific stock in the market.
Be short on a position means to sell the security first to repurchase it later at a lower price. A trader or investor may decide to short a security when he/she believes that the price of that security is likely to decrease in the future.
Below you can see a chart of the ETF SPY (Figure 2), this ETF tracks the S&P 500 Index and contains all 500 stocks in the S&P 500 Index.
Figure 2: SPY vs its short ratio daily
When we observe lower levels of short selling, that means maybe there is too much optimism in the market (Point D), and that’s a setup for a price decline. The opposite can be true when we see an extraordinary level of short selling (Point B), most often due to price decline, is a setup for reversing to the upside. It doesn’t necessarily have to happen all the time, but once you see an extreme you wait to see a turnaround in price.
Indicator 3: Trigger
We use triggers to make trades following a setup. In other words, they are designed to tell the trader the exact moment to execute a trade in the direction indicated by setup indicators (to buy or sell the security).
One of our favorites is the Erlanger Trigger Suite Confirmation (Figure 3). It’s a momentum indicator and basically, you want to be invested in the grey zone and out of the position in the yellow zone.
Figure 3: SPY vs Erlanger Trigger Suite Confirmation daily
Finally, we would also like to share some of Erlanger’s Macro Setup Indicators. One of our favorites is Type 4’s.
There are four types of stocks in Erlanger. Type 4’s or “short recommendations” are stocks that are weak technically (by three internal Erlanger indicators), and when long traders sell Type 4’s they tend to fall at a quicker rate as there are no shorts to cover.
As of October 2nd, 2020 there are few shorts in the current market. The percentage of stocks in the market that are type 4’s is now at 14%. In recent years when this has reached 10% the market has reacted negatively. It did this in February and several times. A percentage above 10% is quite unusual and still suggests risk.
It’s very important to use a tactical trading strategy these days. As you can see, we are not below 10% for Type 4’s (Figure 4), and almost every time it’s above 10% there is a high probability to have a market correction.
Figure 4: The SPY vs Type 4’s percentage daily
In conclusion, this statistical tool offers insights into our portfolio management strategies. It helps to reduce behavioral biases (emotion-driven decisions) and improve equity portfolio performance with easy access to advanced reports and scans.
Lisamarie De Rinjonneau
Senior Portfolio Analyst
To learn more, contact us at:
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