Watching the Forests, Not Just the Trees

Welcome to Guest Post Week here at TRB.  Erik Swarts exploded onto the financial blogging scene back in March of this year with the launch of his site Market Anthropology.  A former geologist-turned-full time trader, Erik brings a scientist’s eye to the data and an artist’s hand to the charts he creates from it.  Below Erik explains why looking at the big picture is so important to those trading individual stocks. – JB

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Forgive the Thoreauvian analogies – there are many.

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Individual stocks dance like Quaking Aspen’s in a warm summer wind. They are the deciduous aesthetics of the system – fluttering back and forth with each respective breeze.

Fourteen years ago I introduced myself to the financial markets by literally just watching those leaves. I might have bought and sold a half dozen stocks over the course of four years. I simply watched the tape wiggle and wondered what the impetus was behind the seemingly erratic movements. I was watching the obvious, yet aware that there were greater forces at work. I just didn’t know where to look.

On an hourly basis most traders are inundated with enough information that would strip a layman of their relative bearings. With the advent of information technologies and the internet, the flow of market moving information has only grown exponential with each passing year. And while that flow has always been the lifeblood for traders, the risk becomes ever greater to not see the forest for the trees.

Good traders synthesize information almost on contact. They will go back and dig deeper for nuance if it colors their thesis – but mostly they discard it back into the stream and continue on their way. At times the information is apparent. Other times it’s more discrete. The key is to isolate the salient signals from the noise.

I have always appreciated charts for their elegance in presenting information in a format that can do just that through contrasts in proportion and juxtaposition. By themselves, an individual stock chart does not tell you much more than price over time. I am not discrediting their utility to traders by any means, but it simply draws the movement of the leaf – it does not give you greater insight into the health of the branches, the trunk or the atmosphere that is working against them.

Here is a very simple – yet effective example of that presentment that I wrote about in my past weeks notes.

The price structure of silver (SLV).

 

The price structures of the euro (FXE) and silver (SLV).

 

The price structures of the euro (FXE), silver (SLV) and oil (WTIC).

From my notes on June 2nd:

“As the euro rips higher today after comments by Jean-Claud Trichet and the newly proposed bailout measures firm the struggling euro-zone, it would be wise to watch silver as a proxy for the currency markets. Since silver broke its parabolic formation over a month ago, both markets have been trading with great correlation – with silver leading the way by several sessions. This makes natural sense in the fact that silver is a much shallower and more impressionable market that will trade with greater nuance to the underlying market conditions. Jawboning by the ECB appears to be only momentarily supporting the euro. I would expect the euro to follow suit lower over the next several sessions.”

From my notes on June 24th:

“In the wake of the SPR news yesterday, it’s hard to deny that the powers that be don’t appear motivated to prick the speculative froth from the commodity bubble. We can debate the merits or shortcomings of these moves from the CME’s increase in margin requirements in silver to the Saudi’s motivation to flood the market with more crude – the simple truth is they have likely contributed to the path of least resistance in the short term.  Here is an updated chart from a few weeks back with one addition – I added oil because it is leading the way lower at this point. It seems like a foregone conclusion that silver – and by extension the respective currency pairs off of the us dollar will embark on their next leg lower.”

There is a fine line between keeping things simple and overcomplicating the obvious. The second and third charts of the series illustrate how looking at different asset contrasts in proportions and congruencies can yield greater insight, than looking at an individual asset by itself. By isolating a few pivotal components, a trader can infer a tremendous degree of information relative to the various kinetic relationships within the markets.

As someone who manages risk on a day to day basis and trades with their own capital, I have found that the best way to effectively succeed is to study the market environment from the ground up. I look for contrasts between sectors, assets and the intangibles of behavioral finance. They are all represented in the charts – you just need to draw them out.

I have always appreciated the following quote because it seemed to fit how I approach constructing a chart and my own research:

“Life imitates art far more than art imitates life… results not merely from life’s imitative instinct, but from the fact that the self-conscious aim of life is to find expression, and that art offers it certain beautiful forms through which it may realize that energy” — Oscar Wilde

My goal with research is to set the aesthetic backdrop of the system, so that I can perceive its components with greater clarity.

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