Financial Market Reader is not a new Technical Analysis indicator.  Lord knows, we have enough of them.  Financial Market Reader is a new method of evaluating existing Technical Analysis indicators.

The Problems with Technical Analysis

• Traditional Technical Analysis only compares a stock to itself. 

For example, a Stochastic Oscillator tells you where the current price is relative to where it’s been the past x number of days.  Relative Strength Index compares up days to down days over a period of time.  These indicators generate buy and sell signals for one stock as if it’s the only stock in the market.  Back-testing an indicator can be misleading because each test only evaluates one stock at a time.  When investing for real, you have to compare stocks against each other, not in isolation. 

• The same indicator value can mean different things to different stocks. 

For instance, a Stochastic indicator value of 20 represents an oversold stock.  However, do not represent the same opportunity.  Only stocks trending upward should be bought when oversold, but identifying the trend is left to your intuition.

• Technical Analysis doesn’t help you evaluate stocks relative to one another.  

You have to look at each company’s chart in isolation.  By the time that you look at all of the charts, you’ve forgotten what you saw on the first one.  But if you’re tracking 500 stocks, you might get 50 signals a day when you can only afford to invest in five.  Which five?  It gets back to guesswork. 

• Since Technical Analysis signals have to be interpreted, they are more subjective than objective. 

In general, you are supposed to buy when an indicator crosses a certain value or its moving average.  But then there are additional considerations like market trend, whether the current crossover is greater than the previous one, etc.  There is no way to gauge the importance of these caveats.  Apparently, you’re supposed to eyeball these factors together with the indicator and then make a guess. 

• Technical Analysis signals are often unprofitable. 

Every technical analysis indicator is based upon sound logic.  I’ve read a dozen books on technical analysis and they all sound perfectly logical.  They all display charts that prove that at some point in the past for some stocks, their system has been spectacularly profitable.  Applying the methods in the future that is tricky.  They all work in the past with their cherry-picked examples, but when you apply the formulas to all stocks and all dates in the future, the systems can be spectacularly unprofitable. 

Shouldn’t a method of analysis based upon formulas be more objective than that?

Objective Analysis

Really, when we look at a stock graph, aren’t we really trying to understand whether the stock is likely to rise or fall?  I just want to know the percentage chance that the stock will be higher or lower in the future based upon its past.  I want to know how much I can reasonably expect to make.  These are numbers that I can use to compare one stock to another.

The Financial Market Reader approach is to apply pattern matching and quantitative analysis to the technical indicator.  The process is similar to how the weather is forecasted.  Essentially, meteorologists tell you that it rained fifty out of the last one hundred times that the temperature and barometric pressure values resembled today’s readings.  Obviously, the weather service considers more than two factors when predicting the weather.  It is the process in which we are interested.

What Financial Market Reader does is compare an indicator’s recent history to all periods in the past.  Then we calculate a WLP (won-lost percentage) and P&L (profit-and-loss) average for the next day and week using the most similar points in history.

You can then sort the results by either WLP or P&L to quickly determine the stocks with the most potential without any guesswork or intuition.

Future Breadth

Market Breadth tells us how many stocks have risen with the idea that it is good to buy when most stocks are rising.  Financial Market Reader extends this idea by summing the WLP for each stock in the market (we currently follow approximately 1,100 stocks). 

Obviously it’s better to buy when more stocks are forecast to rise than fall. Like counting cards in Vegas, you’re placing bets when you are more likely to win.

Caveats

Certain scenarios don’t forecast well. Trend tops and bottoms kill this type of system. Suppose that the market is in an uptrend and every dip has been a buying opportunity. When the market finally turns downward, Financial Market Reader is going to register a strong buy since it thinks that dip is just another opportunity. 

Also, history obviously cannot predict something that hasn’t happened before. If a company sells off because it reports a loss for the first time, looking at the stock’s history isn’t going to help you.