(This article first appeared in the Q3 issue of GlobalTrading.)
By Phil DeFrancesco, Global Head of Equity Trading, Refinitiv
How has the trader’s approach to the market changed amid COVID-19?
COVID-19 has completely thrown trading desks on their heads. First, traders have had to work remotely and maybe adopt new technology, and they’ve had to do this pretty much overnight, whereas in the past it would have taken years to implement. Second, traders have had to deal with extraordinary market volatility.
This volatility can be seen as a double-edged sword. But what it does do is present more short-term trading opportunities for traders to act on. Equity markets have behaved very irrationally, and it is very difficult to make sense of some of these sudden upside or downside stock price movements. One day, there is what we call a ‘dash for trash’, as investors look to scoop up companies that are out of favor due to COVID-19. The next day, the market rolls over on fears of a second wave of the virus, and the next day, it pops because there’s hope for a vaccine. And then the cycle repeats.
This level of uncertainty and volatility in the markets is a playground for the short-term trader.
What role can technical analysis play in navigating the uncertainty of today’s trading environment?
The idea that the S&P 500, which is valued on discounted future corporate profits, is positive for the year, seems absurd. On August 18, the S&P closed at an all-time high. People who trade solely on fundamentals must be having fits. Given the volatility we have seen in 2020, it is no surprise that data shows long-only has been one of the worst trading strategies year-to-date.
In times like these, one cannot underestimate the power of market sentiment, as it influences the technical indicators traders use to make decisions, and it is the crux of what technical analysis feeds on.
There’s an old Wall Street term, “The trend is your friend,” which suggests investors take advantage of existing trends. Now, predicting market trends in advance is tricky business. Identifying existing trends and riding that wave could increase the odds of making a profit, but the key is being able to identify those existing trends — this is where technical analysis comes in. Examples of technical indicators that seasoned traders use to identify trends are a stock’s moving average; its trading volume; its relative strength index (RSI); and its moving average convergence divergence (MACD). Traders will often use a combination of indicators to capture gains through this analysis of a security’s momentum. Traders and portfolio managers can also use technical analysis to identify favorable entry and exit points for potential trades.
What data, analytics and other tools does Refinitiv leverage to support clients who use technical analysis in their trading?
Refinitiv’s flagship desktop product Eikon provides state-of-the-art charting capabilities, which traders and portfolio managers can use to easily perform technical analysis. Eikon is equipped with hundreds of the most widely used indicators, and its charting capabilities allow traders to mark up charts to help identify trends and patterns.
Refinitiv also partners with vendors including Tradesignal and MetaStock to bolster our offerings in this space. MetaStock, has been a tremendous partner of ours for almost a decade, and our partnership allows our users to take their technical analysis skills to another level by creating their own scenarios. The MetaStock Pro for Eikon, which is an add-on for Eikon, has an easy to use, built-in language for creating and writing strategies. The solution also offers backtesting and optimization capabilities, along with the ability to create sophisticated alerts, such as automated buy and sell alerts. The MetaStock Pro for Eikon solution even offers an advanced tool for forecasting future direction based on past technical criteria.
What are a few examples of technical analysis working for traders this year?
The 200 simple moving average (SMA) has been a big support for the Dow over the last year (Figure 1). It has often reverted to the mean. Typically, a break below a support level will show a short- to mid-term drop. When Covid-19 hit, it broke through the support and tried to revert to the mean; it then used it as resistance and didn’t have the strength to push through. That is when we saw the big drop. After a rebound, it entered a period of indecision around the 200 SMA.
Another example (Figure 2) is Walmart (WMT), a stock that has had a surge in trading during the pandemic. It also is very interesting based on the Fibonacci retracements. The major theme with Walmart is that it has a major retracement line around the 118 price. This price has been a key level since September 2019. In April 2020, the price surged past 118, then retraced back to this Fibonacci level. The April move higher could be seen as a precursor to the price reverting back to the 118 level, based on the pattern of the past two years, which shows that Walmart has used retracement levels as key support and resistance levels.
Fast forward to whenever the COVID-19 market is fully over, in six months or one year or two years. What do you see as the key themes regarding technical analysis at that time?
Technical analysis has been a very important tool for traders for a long time and there has always been a bit of a love/hate relationship between fundamental analysis and technical analysis.
But, there is a middle ground. Can you use technical analysis even if you primarily look at the fundamentals of a company? In the past, I think you belonged in one of the two camps — either you’re a fundamental analyst, or you’re a technical analyst. Some fundamental analysts would even consider technical analysis sort of a self-fulfilling prophecy.
There may be some more appreciation for technical analysis by the broader investment community, in the post-COVID-19 world. Technical analysis can help paint a clearer picture of the overall market sentiment and what’s happening out there. Sometimes, the market, or an individual security, doesn’t move in a way that you had anticipated, but that doesn’t mean you can’t find alpha there. So when the dust settles and everyone goes back to “normal”, I think there’s going to be a greater appreciation for what technical analysis can bring to your overall investing approach.