Chart reading, rhythms, crowd behaviour and the shape of charts. Where are we now?

I am sitting and worrying. My Chinese shares are doing OK with the exception of three, all in the same sector - internet real estate marketing (SFUN, EJ and LEJU). These are going to be ditched at the open of today's market.

Since the others are holding up in the face of a strong head wind I am going to keep them pro tem. (BIDU, BITA, NTES, NOAH, FENG, YY, VNET, VIPS, XRS, WBAI).

To hedge my position I am holding a small chunk of VXX which moves in the opposite direction from the market. A bit like a contra ETF but this one is based on the VIX which measures the "fear factor" in the S&P. I have an order to buy more at the open of the US market. So there's my strategy for the US market.

In the UK I have bought and am holding a batch of shares picked by my oldest and best share picking system. I started buying on 1st July and overall they are up 2%, pretty good in a market that is down 3% in the same period. (EXI, WIN, BRIT, CAML, GEMD, RNWH, OMI, PUR)

So the big question is where are we?

Chart reading 

Eoin Treacy quotes Dietrich Bonhoffer at the beginning of Crowd Money:

"If you board the wrong train, its no use running along the corridor in the other direction"

So which way is this train going?

Crowd Money puts forward the case for "Chart Reading" as a discipline quite separate from "Technical

Analysis." The difference, Treacy says, is that chart reading is the examination of charts to try to determine what they imply about "the actions, objectives and motivations of market participants." Chart movements show us the balance between supply and demand which in turn tells us whether buyers or sellers are in the ascendant.

Technical analysis, he defines as a technique which looks at the relation price to itself. It attempts to identify patterns and the opportunities that those patterns identify.

What Treacy is trying to identify are the rhythms of the market. There are two clear rhythms. These are trends when either demand or supply are in the ascendant. In these cases the market trends up or down depending in whether there is a preponderance of buyers or sellers. When there is a balance between buyers and sellers the market ranges until a new trend emerges.

The rhythms of crowd behaviour and the shape of charts

Four factors drive these rhythms for they create demand or supply. They are;

• the story: a shift in the fundamentals of a market is identified and broadcast to participants: a new technology, a shortage of supply due to inadequate investment, a surplus caused by a reduction in demand by a major buyer. The propagation of information of this sort can fuel a bull or bear market as participants are convinced of the veracity of the story and the belief that it will influence the price of an asset which they own or wish to buy
• liquidity: the easy and cheap availability of cash for buyers to participate in a market that is running is an important factor that fuels a bull market. The sudden withdrawal of that pool of money, or a hike in interest rates will rapidly put a brake on the move and throw it into reverse
• governance: a good legal framework. One that encourages participation in a market and allows good investment decisions to be made easily so productivity is enhanced, can make the difference between a market that grows and one which stagnates
• price action gives credence, or otherwise to our beliefs about what is happening in the market. If the price moves relentlessly in the opposite direction to the one predicted by our theory about the market, then we can be sure our theory is wrong. Price is the ultimate reality check.

With these four determinants in mind we can watch the market as we watch a herd of animals running across an African Savannah. The herd runs smoothly in one direction until the motivation for that move is exhausted and the group, all of its individuals moving independently swings and adopts a different direction.

The story has changed, or liquidity has dried up, or the regulation regime has been modified. But most of all we see the shift in direction.

Because the crowd is made up of individuals they do not always move as one and that is what makes reading the market difficult. A part of the herd may break away and attempt to pull in a different direction. Is that the beginning of a shift? Or will they be dragged back into the heart of the herd?

That is exactly where we are now. A breakaway is happening. The story of the market has not changed. If anything it is more favourable with economic conditions improving in some places. But there is a serious threat to liquidity. QE is coming to an end. Nevertheless we are not there yet. Interest rate rises are threatened but guidance suggests that the moment will be later rather than sooner.

So what we are seeing is a significant element in the herd of market participants taking fright. Will the herd turn to follow them and stampede in their direction? Or will the nervous ones be overwhelmed by the larger part of the herd? Will th majority see that plenty of money still flows into the hands of potential buyers? And will those buyers take advantage of the lower prices that the breakaway elements have generated?

We watch the price and we shall see.