Interactive Investor

Chart of the week: A contrarian bank trade

10th October 2016 12:19

John Burford from interactive investor

My headline indicator is working overtime

Last week, I showed how, by using my simple and very unscientific headline indicator (HI), it is sometimes possible to locate time-accurate contrarian trades. I gave the example of Centrica that made a low just as Questor had finally thrown in the towel in February and advised 'avoid' in no uncertain terms.

The actual low was made almost to the day of that article. Whether it is "the low" remains to be seen, of course.

Naturally, the article contained much of the bearish fundamentals that were well-known and had been in place for some time. There was nothing really new in the negative department- and thereby hangs a tale of a market ripe for a reversal.

Does anyone know all of the background fundamentals of a share, anyway? We all suffer from confirmation bias, don't we? If we are politically inclined, does any red-blooded free-market libertarian read the Guardian day in and day out? Not too many is my guess.

Classic herding

That is because we are drawn to copy that is in synch with our political views and that gives us that warm glow of reassurance that comes from knowing we belong to a like-minded and well-educated group! That is classic herding.

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Does a rabid Manchester United fan avidly read match reports of Manchester City every week? I thought not.

And this principle of herding applies especially in the financial arena. For those who understand how herding drives markets to extremes, a canny operator can enter trades against the herd - and profit handsomely.

The wonderful thing about the HI is that it can often pinpoint market reversals very accurately - often to the day, as in my example here. By the time the mainstream media (MSM) have deemed a well-developed trend worthy of extensive coverage - and give it stark headlines - the trend is usually about over.

Now why is that? For a start, most financial journalists have a conventional belief system of how markets work. That is, they subscribe to the false theory that it is the news that makes the markets (in fact, it is the reverse).

Therefore, they apply logical thought to the news and data and, of course, in a bear trend they find only bearish data. Because most readers are bearish, they find a ready audience - and sell lots of papers and attract lots of clicks!

Another real-time example

And here is yet another real-time example of HI at work - with Deutsche Bank.

DB is traded in New York (and Frankfurt) and so was of little interest to most UK investors and journalists - until last week when it suddenly hit the headlines, and today it features prominently in the financial pages of most MSM outlets. Suddenly, spread betting platforms are featuring it.

Here is the share chart going back to 1995:

Not much joy for investors here, is there? There have been two major bull runs since 1998, but everyone who is still holding is losing money. Only the shorts are happy!

The market has been in a steady downtrend since the most recent high six years ago. And now the MSM has suddenly noticed! I guess it sometimes takes six years to notice a clear trend for some.

Here is what the Telegraph headlines said on 30 September: "Why is DB the biggest worry in the financial world?"

What a disastrous investment DB has been - from 150 to 10 in eighteen yearsBut, of course, what the writers noted was the all-time low made last week below €10, which stirred them into making that very bold claim.

But is DB really the biggest worry? What about China? The Telegraph reported a few days later at the weekend that "China faces calamity if it does not wean itself off debt", according to the International Monetary Fund.

So DB is not the biggest worry after all - it must be China! It's hard to keep up with the multitude of calamities heading our way, isn't it?

But what a disastrous investment DB has been - from 150 to 10 in eighteen years.

But has my HI indicated the end of the bear trend in a timely way?

Here is the weekly chart, and it has two striking features:

The trading volume the week of 30 September was enormous - much bigger than in any other week. And that spike in volume at the low says one thing loud and clear - there was a selling exhaustion.

Many tired bulls decided to get out before it went to zero - and at the same time, many short sellers decided to take profits by "covering" their shorts by buying them back.

Third-quarter results are due on 27 October - what's the betting they're better than expected?That was when the MSM reports were full of gloom-and-doom that signified a high in bearish sentiment that was indicated by my HI. And a contrarian trade was presented.

Note also the rising moving average convergence divergence (MACD) indicator as the market dropped to the low; that suggested a gradual weakening of selling pressure which inevitably leads to a reversal.

Third-quarter results are due on 27 October - and what's the betting they will be better than expected?

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