Math Over Myth: A Primer
Retail investors are seizing more control over their respective financial futures by cutting out middlemen, educating themselves, and making their own investment decisions. “Math Over Myth” intends to remove the romance from investing and focus strictly on charts, mathematics, and technical analysis.
Regardless of sector/company news or rumors, math is one of the only provable methodologies in existence. Corporate word salad press releases often hide behind Safe Harbor or Forward Looking Statements but can’t hide from math. These statements can often be misleading, investors regularly mistake them for statements of fact, and yet they are actually nothing more than speculation.
Sounds simple enough. But how does this all work?
Thankfully, centuries of work already contributed to this ever-growing discipline. A 13th century mathematician from Pisa, Tuscany named Leonardo Bonacci, later known as Fibonacci, popularized the Indo-Arabic numeral system in the West through his 1202 work Liber Abaci (Book of Calculation), in which he introduced Europe to the Fibonacci numbers sequence:
Fibonacci numbers appear unexpectedly often in mathematics, so much so that there is an entire journal dedicated to their study, the Fibonacci Quarterly. Applications of Fibonacci numbers include computer algorithms such as the Fibonacci search technique and the Fibonacci heap data structure, and graphs called Fibonacci cubes used for interconnecting parallel and distributed systems. They also appear in biological settings, such as branching in trees, the arrangement of leaves on a stem, the fruit sprouts of a pineapple, the flowering of an artichoke, an uncurling fern, and the arrangement of a pine cone‘s bracts.
Examples of Fibonacci curves, sequences, and spirals are all around us every day, including sea shells, sunflowers, the bass clef, a spiral staircase, and even the Mona Lisa!
So how did a 13th century Italian mathematician end up being so relevant to analyzing price movements in the modern stock market?
It’s entirely based on the Fibonacci number sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, … Each number is the sum of the two preceding ones.
Moving Averages help gauge a stock’s general trajectory and identify levels of support and resistance. You’ll see me refer to EMA (exponential moving and average) and SMA (simple moving average). A simple moving average is just that, a simple average of all closing prices over a specified period. For example, a fifty-day (50D) SMA contains the previous fifty closing prices averaged at equal weights.
However, the exponential moving averages give more weight to the more recent closing prices. The twenty-day (20D) EMA gives weights more value on today’s closing price than the closing prices from two weeks ago. This shows more trajectory and volatility, while the 50D SMA is a smoother, less volatile line of best fit.
A Golden Cross occurs whenever the 20EMA crosses above the 50SMA, and is a very positive sign. Since the chart is “upside down” when the shorter-term moving averages are below the longer-term ones, this signals a potential trend reversal,.
A Death Cross occurs whenever the 20EMA crosses below the 50SMA, and is a very negative sign. Since the chart is “right-side up” when the shorter-term moving averages are above the longer-term ones, this also signals a potential trend reversal.
When a stock is locked in a channel, it can be trending either up or down. There are two trend lines, one acting as support, and the other resistance. While inside a channel, the stock price will often oscillate with volatility from the top of the channel, where it typically meets resistance, ti the bottom of the channel, which usually acts as support.
When a stock is consolidating, it trades inside a horizontal range. This is a good sign, and one of the favorite set ups for professional traders. When a stock is range-bound, there are two horizontal price levels, one acting as support and the other resistance. While inside a range, the stock price will often oscillate with volatility from the top of the range, where it typically meets resistance, to the bottom of the range, which usually acts as support. This is often referred to as “trading sideways.”
Professionals will buy at the bottom of the range and sell at the top as the stock consolidates, then buy the breakout if and when the stock eventually breaks and sustains above the top value of its range. To protect profits, traders often use a trailing stop in line with their risk tolerance. Moreover, to mitigate a potential breakdown, professionals will employ a stop loss strategy to minimize losses if the stock happens to drop and sustain below the bottom value of its range.
Craig D. Schlesinger is the CFO of PSYC Corp & Spotlight Media and a market analyst with over twenty years experience predicting price movements and trend reversals in various sectors. Follow his #MathOverMyth technical analysis and him on Twitter: @psychedelicraig