Cestrian Stocks Bulletin

By Cestrian Capital Research, Inc

"That's Just Drawing Any Old Lines" (Cestrian Stocks Bulletin #101)

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Cestrian Stocks Bulletin
"That's Just Drawing Any Old Lines" (Cestrian Stocks Bulletin #101)
By Cestrian Capital Research, Inc • Issue #101 • View online
How to measure fear and greed.

DISCLAIMER: This note is intended for US recipients only and in particular is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents or affiliates, including the author of this note, or related persons, may have a position in any stocks, security or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note’s date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.
The Illusion Of Free Will
It’s easy to write off technical analysis as “too difficult”, “something other people do”, or, our own favorite, “that’s just drawing any old lines”. The name alone is off-putting. ‘Technical’ speaks of matters complex and mathematical, beyond the reach of mere mortals and belonging only in the silica towers of Wall St’s finest. Perhaps this was once true, but like everything else it has touched, the Internet has ruined all that. With a free account, sites like TradingView, Barchart and others now give you the tools that did once require mathematical skills - oh, and a ruler - to deploy on a stock chart.
You can spend hours, days, whiling away time looking to see when the S&P or your favorite stock has formed various patterns - cups, handles, heads, shoulders, the Yikes Cat, and so on. Now, whatever any FinTwit genius tells you, no technical trader is the Master Of All Patterns, and if there’s a software package that can master all patterns for you, we’ve yet to hear of it.
No, the trick in our view is to find a method, a pattern, that you can spot at fifty paces, and keep looking for that pattern. Trade the patterns with paper money, or real money, but small money so you don’t burn yourself too much whilst you’re learning to spot that pattern. Then, if you get good at it, trade with bigger money as your success rate increases.
The Yikes Cat (Source: TradingView.com)
The Yikes Cat (Source: TradingView.com)
For us at Cestrian, we like using the patterns provided by the Fibonacci sequence. We wrote recently about a specific kind of Fibonacci level that is proving effective for us - you can read that note here - the note includes links to the Investopedia page which will help you if you are new to Fibonaccis or you have some familiarity with them but they make your head hurt so you stopped bothering. (Try again. It’s not that hard, really. People want you to think it’s hard. It’s not.)
We like the Fibonacci patterns because they are less subjective than most, which mean less likelihood of seeing things one wants to see. This is because the distance between the Fibonacci levels on the chart is defined by the Fibonacci sequence of numbers itself - you don’t have to guess where to put them. And those levels are themselves determined by reference to the ‘golden ratio’ - 1:1.618 - seemingly a fundamental constant of nature and indeed apparently a building block of the emotion underpinning the fear/greed motivation. It’s the case that if you overlay a Fibonacci sequence on most any liquid security, you can find that the security respects the levels as support and resistance at various times. Whether this magic is a result of it being a self-fulfilling prophecy - folks just trading to the sequence on purpose - or whether it’s a kind of codified method of understanding trader emotion - we don’t know. If we’re honest we think a little of both.
Self-fulfilling, because, for instance, most people know that a 78.6% retracement of a prior high is a brutal correction that can likely be bought safely. That a 3.618 extension of a trend, projected from a reversal trough, is a sugar high that should probably be sold.
But also genuinely insightful, because if you start to project extensions and retracements in a non-textbook way, you can also see securities respect the levels as support and resistance levels, and since your method of choice is not in any textbooks, there must be something about those retracements and extensions which map to the fear and greed that runs in each and every trader’s veins and which as a result runs in the code of the algorithms that traders write.
Here’s how we use Fibonaccis in our staff personal account work and the stock ideas in our various newsletters and other pay services.
  1. We fundamentally and unshakably see the truth that the levels within any correctly-drawn Fibonacci sequence has explanatory power for historic securities movements, and predictive power for future movements. Specifically, the prices at which securities will find local areas of support and resistance. Not perfectly predictive, rather, capable of predicting highly probable events. Probably stock X will pause at a 100% extension. Probably Y will reverse at the 0.786 retracement. And so on.
  2. We use retracement - pullback - measurements to consider when we might reasonably buy into stocks we like at advantageous points, whether they be new names or adding to existing holdings. Just today we added to Cloudflare ($NET) in staff personal accounts because it bounced off of a 0.618 retracement from the prior run up. (Last week we sold the $NET puts with a $160 and $120 strike that we had bought during the run-up. Sold too early as it turned out, though we sold profitably. Those put strikes were selected based on the same Fib sequences we used to judge today’s buy. $NET by the way has been a huge winner in our pay services).
  3. We use extension - run-up- measurements to consider when we might take some or all profits on a name. Some profits if it’s a stock we want to own long term; all profits if it was purely a trade.
  4. We use the levels below where we buy as actual or notional stop-loss triggers.
If you learn to use these simple tools - they sound complicated but with practice, they aren’t - then armed with your charting website, you can go hunting - retracement and extension hunting.
The true value of that Golden Ratio basis is that as long as you pick an important start point from which to measure your retracement or extension, the sequence does seem to be powerful. And that in our view comes down to “market memory” ie. trader emotion. You can project extensions from recent highs as well as from retracement lows, and still get useful results. The only judgment required is, pick a sensible start point - usually when a security gaps up or down, or strikes a marked new low or high; and then modify the timeframe you are looking for until you find the sequence gives you some explanatory power over previous price action. Assuming a reasonably long timeframe - say months or more - you can then have some belief in the predictive power too.
Here’s HubSpot ($HUBS) for instance. Started a run up in mid 2017; peaked right before the Covid crash; bottomed out almost precisely at the 0.786 retracement. And for the avoidance of doubt, yes, we specifically chose the start point of this chart so that the Covid low was a 0.786 retracement. Arbitrary you might say - drawing any old lines. But the reason we did that is because we think that projecting - extending - the trend from such a point has predictive power. And lo, did the stock hit the 4.236 extension when started from the prior high .. and yea verily did we sell down the stock in staff personal accounts having first declared in our real-time Growth Investor Pro service that we were doing so. Which proved wise, since the stock is now retracing its steps - currently the stock sits at the 0.236 retracement of the move up from the Covid crisis lows. (Full page chart is here ).
Source: TradingView, Cestrian Analysis
Source: TradingView, Cestrian Analysis
Right now with the market committing heinous acts of self-harm, many high growth stocks are diving for cover, and we have started to pick up some of those fallen angels - $NET for one, $GTLB for another, $ASAN for another. Here again, Fibonacci can help you. If you take the example above, you could consider buying a little at the 0.236 retracement; a little more should the stock approach the 0.382; more at 0.618. You can also say that probably $HUBS stock won’t fall below the 0.618 level in this move down because this is a Wave 4 not a Wave 2 … but that’s some next-level voodoo and we can talk about that another time.
For now? Get your crayons out and get drawing(*). Any old lines, as long as they prove explanatory. Because if they prove explanatory looking backwards, and if you draw the extension correctly going forwards, likely you have some predictive power right there. And that’s not nothing.
(*) NOTE - if you prefer to, you know, play sport or read books or talk to people or all that neurotypical stuff … you can just subscribe to one of our services where we do all this charting stuff anyway and are always happy to share it with you. On the subject of which …
NEW! Tech Letter From Cestrian Capital Research
This week we launched our newest service, Cestrian Tech Select. It comes in free and paid versions. Sign up for the free version, here, see if you like it, and if so, consider the actionable paid version. It runs on the very neat Substack platform which our readers find works well for them. Get Cestrian Tech Select for FREE!
Cestrian Capital Research, Inc - 14 December 2021.
DISCLOSURE: Cestrian Capital Research, Inc staff personal accounts hold long positions in, inter alia, HUBS, NET, ASAN, GTLB.
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