Quantitative study of the markets has become incredibly popular over the past few years. Looking at specific, technical stock market events and then backtesting to see how the market performed after similar events in the past has become the pastime of many a market watcher. And it’s valuable stuff. But the real value is in how you use it.
I have argued in the past that some analysts using data in this way can become far too reliant on it alone. The process becomes too mechanical as it eliminates any real thinking or true analysis. And no matter how far technology takes us, critical thinking will always be an integral part of successful investing.
One area I see investors possibly making this mistake today, is in putting too much faith in bullish studies while stocks remain in a downtrend. As Paul Tudor Jones suggests, whether an asset is trading in an uptrend or a downtrend is of primary importance. Everything you study should be looked at in that context.
For example, a “Zweig Breadth Thrust” was recently triggered in the stock market. This has bulls seeing dollar signs. However, as Tom McClellan recently noted, this indicator works great when stocks are in an uptrend but when they’re not it’s track record is pretty poor. In fact, if used alone, this indicator would have had you getting bullish at some of the worst times over the past century.
— Jesse Felder (@jessefelder) October 12, 2015
This can be said for almost any quantitative study like this one. The primary trend matters. Ignore it at your peril.