Stock patterns reveal human nature

AS OF the end of last week the indices continued to trade sideways, but the All Ordinaries was the only index of the three majors to close the week above 5800 points.

As I have said before, I would remain very wary of the market until all three of the indices (the All Ords, ASX 200 and the SPI Futures contract) close decisively above 5800.

That close above 5800 would be the trigger to begin trading with confidence.

I also mentioned that the longer the sideways move continued, the stronger the break from the move – up or down – would likely be.

I did, however, believe the break would likely be to the upside. As you may be aware, this column is now written after the market close on Wednesdays – and the break occurred to the downside with a vengeance.

My wariness to buy before the break was vindicated, but the move did not cause stocks right across the board to follow suit.

The majority of the stocks flagged in my market scan last weekend had held their ground as of the end of trade on Wednesday. The one stock in the portfolio, Tawana Resources, remained unchanged on the day and, I might add, since purchase.

The gap between the indices opened slightly, indicating the professionals in the futures market were not spooked into driving the futures much lower, as often happens when the market has a rapid sell-off.

That said, a move of this magnitude indicates lower lows to come and this often happens soon after the big move and may indicate the reversal of the move.

It now remains to be seen if this turns out to be a false break, which means the market will quickly move back to the level of the sideways move. If this occurs, then the move to the upside would be swift. But as I write, I am pleased to be still on the sidelines.

It was interesting to see the divergence mentioned between BHP Billiton and Rio Tinto follow through during last week as both moved up strongly, and fell this week, but did not trade down to the recent spike low.

There was a divergence between the ASX 200 and the SPI futures at the end of last week, indicating a move down – which certainly came to pass on Wednesday.

Looking for divergences between the indices is certainly worthwhile. They occur when one of a pair of stocks or indices that trade in tandem, trades above or below a previous spike high or low and the other fails to trade above or below its equivalent point.

It seems that apart from the fundamentals that stock values are loosely based around, they are also moved to highs and lows by the fears and greed of the people trading them. As these patterns form in a similar manner across the board, it seems human nature is a major contributor to the formation of these patterns.

The big challenge for traders is to figure out how to read the nuances of these patterns and use them to advantage.