SAMT Journal Spring 2017 by Swiss Association of Market Technicians

THE SWISS

TECHNICAL A N A LY S I S JOURNAL SPRING 2017

Frühjahr Primavera Printemps Spring 2017

The Swiss Association of Market Technicians ZÜRICH • GENEVA • LUGANO • CHUR

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From the President’s Desk

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Dear SAMT Members & Industry Colleagues, As with every Journal, we feature articles by industry experts about technical analysis. This issue is no exception - but five of the articles were written by speakers of the upcoming IFTA Conference in Milan in October. First is an interview between our SAMT Vice President and Editor, Mario V. Guffanti and Francesco Caruso who is co-chair of the conference, and next, Francesco tells us about his Fear/Complacency Index on page 8. We hear from Professor Hank Pruden about Combining the Wyckoff Method and the Elliott Wave Principle in a Life Cycle Structure of Market Analysis on page 11. On page 18, Perry Kaufman shows us how to get Get Higher Returns When You Create Your Own Sectors and Robert Prechter shares an excerpt from the first chapter of his new book, The Myth of Shocks, on page 23. SAMT Vice-President, Alberto Vivanti, gives us Some Thoughts about the Construction Process of a Sector Rotation Strategy on page 28. Along with the conference speakers, we have three additional interesting articles: We learn about the Eight Widespread Misconceptions About Bitcoin by Giacomo Zucco on page 33 - which is timely after the recent wave of “ransomware” attacks (ie the infamous “Wannacry”). Paulo Musto talks about Monetary Policies and the Current Juncture on page 37 and SAMT VicePresident, Ron William, writes about the EUR/USD: Parity Target, a Clear and Present Reality on page 44. This year’s IFTA conference, hosted by SIAT, will be held in Milan with the theme: “Sailing into the Future”. If the conference is anything like their introductory video, it should be a most successful event. Consider attending the conference in October - it would be wonderful to see so many of our SAMT members and industry colleagues in Milan. Sincerely yours,

Patrick Patrick Pfister, CFTe, President of the Swiss Association of Market Technicians (SAMT)

The Swiss Technical Analysis Journal • Spring 2017 • 3

THE SWISS

WHAT’S INSIDE

TECHNICAL ANALYSIS JOURNAL

IFTA 30TH ANNUAL CONFERENCE, MILAN AN INTERVIEW WITH FRANCESCO CARUSO Mario V. Guffanti, CFTe

Volume Five • Issue 1

SPRING 2017

FEAR/COMPLACENCY INDEX (FC INDEX) Francesco Caruso, MFTA

Journal Committee Mario V. Guffanti, CFTe + 39 33 691 91 70 mario.guffanti@samt-org.ch Ron William, CMT, MSTA +44 7857 245 424 ron.william@samt-org.ch Design & Production Barbara Gomperts +1 978 745 5944 (USA) barbara.gomperts@samt-org.ch

GET HIGHER RETURNS WHEN YOU CREATE YOUR OWN SECTORS Perry Kaufman

BOOK REVIEW The Socionomic Theory of Finance Henry “Hank” Pruden, PhD

THE MYTH OF SHOCKS - An Excerpt from Chapter 1 of The Socionomic Theory of Finance Robert Prechter

Follow SAMT on SOME THOUGHTS ABOUT THE CONSTRUCTION PROCESS OF A SECTOR ROTATION STRATEGY Alberto Vivanti

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GENEVA: HIGH-LEVEL NETWORKING OPPORTUNITY FOR FINANCIAL PROFESSIONALS Mario Valentino Guffanti, CFTe

EIGHT WIDESPREAD MISCONCEPTIONS ABOUT BITCOIN Giacomo Zucco

MONETARY POLICIES AND THE CURRENT JUNCTURE Paolo F. Musto

EUR/USD: PARITY TARGET, A CLEAR AND PRESENT REALITY Ron William, CMT, MSTA

To read articles on issuu.com from the past three years of The Swiss Journal of Technical Analysis, click here.

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The Swiss Association of Market Technicians (SAMT) is a not-forprofit organization that does not hold a Swiss Financial Services License. It is the aim of the SAMT to promote the theory and practice of technical analysis, and to assist members in becoming more knowledgeable and competent technical analysts, through meetings and encouraging the interchange of materials, ideas and information. In furthering its aims the SAMT offers general material and information through its publications and other media. The information provided on this Journal has been compiled for your convenience and made available for general personal use only. SAMT makes no warranties implied or expressly, as to the accuracy or completeness of any information contained on the Journal. The SAMT directors, affiliates, officers, employees, agents, contractors, successors and assigns, will not accept any liability for any loss, damage or other injury resulting from its use. SAMT does not accept any liability for any investment decisions made on the basis of this information, nor any errors or omissions on the Journal. This Journal does not constitute financial advice and should not be taken as such. SAMT urges you to obtain professional advice before proceeding with any investment. The material may include views and statements of third parties, which do not necessarily reflect the views of the SAMT. Information on this Journal is maintained by the people and organization to which it relates. The SAMT believes that the material contained on this Journal is based on the information from sources that are considered reliable. Although all care has been taken to ensure the material contained on this Journal is based on sources considered reliable we take no responsibility for the relevance and accuracy of this information. Before relying or acting on the material, users should independently verify its accuracy, currency, completeness and relevance for their purposes.

The Swiss Technical Analysis Journal • Spring 2017 • 5

IFTA 30th Annual Conference, Milan An Interview with Francesco Caruso Mario V. Guffanti, CFTe The first IFTA conference was held in 1988 in Tokyo, hosted by the NTAA. Since then, IFTA has held an annual conference in different locations throughout the world, usually in the autumn, hosted by the member society of that country. SIAT hosted its first conference in 1998 in Rome, and this time, the conference will be held in Milan. The event is organized by SIAT (Società Italiana di Analisi Tecnica), which is the IFTA member Society for Italy, and I have the pleasure to share some details of this conference from one of the organizers of the event, Francesco Caruso, SIAT Vice President and head of the Scientific Committee. Mario V. Guffanti (MVG) - Hi Francesco, it’s a great pleasure to interview you about the next IFTA conference that will be held in October in Milan. Francesco Caruso (FC) - It is a great pleasure for me to be interviewed in your beautiful SAMT Journal, and I really compliment you on the dissemination and the quality of both content and format. MVG - After nine years, the 2017 IFTA annual conference will be back in Italy. What motivated you to propose Italy for the 2017 conference? FC - The choice to propose SIAT to host the conference is due to a number of factors. First, as you pointed out, it has been nearly 20 years since an IFTA conference was held in Italy, a long time for a country with long traditions in technical analysis like ours. Second, in 2016 SIAT changed directors and one of the mandates of the newly-elected directors was to try to bring the IFTA conference in Italy. In addition, Italy and Milan hosted the 2015 Expo so now everyone in the world knows of Milan. MVG – Last year the IFTA conference was held last year in Sydney, with two SIAT speakers: you, with a revisit of the trend that leads to an original multi-strategy portfolio; and Andrea Unger with a speech about the evolution of Algorithmic Trading and the role of Technical Analysis. Were these topics in anticipation of what will be covered in the Milan conference? FC - Absolutely. The title of the conference, “Sailing to the Future”, will allow us to go beyond the usual themes of Technical Analysis, exploring a sea of opportunities originated by a totally new “quant” generation of technology, markets and instruments. We will also try to go inside the vast theme of the collaboration between our discipline and many other fields of economics (i.e. Behavioural Finance, AI, Big Data, Cryptocurrencies), with top institutional and academic contributions.

Each speaker will be selected with regard to its added value to the participants and to the overall evolution of Technical Analysis. I can also say that our idea has had an enthusiastic response and I can already announce the participation of speakers such as Robert Prechter, John Bollinger, Professor Hank Pruden, Perry Kaufman, Gregor Bauer, Riccardo Ronco (HF manager Caxton and IFTA 1998 Speaker on Chaos Theory, multiwinner of the European Technical Analyst Award), Andrea Unger, Richard L. Peterson (author of “Trading on Sentiment” and CEO of MarketPsych), Kathryn Kaminski (fund manager and author of “Trend Following with Managed Futures: The Search for Crisis Alpha”), Spiros Skouras of The Scientific Fund, and Alberto Vivanti from SAMT. And many others will be joining us, thanks to the efforts of our President, Davide Bulgarelli. MVG - Let’s speak about the presence of Technical Analysis in Italy: how has it evolved over the past decade and what is the actual state of the art? FC - Technical analysis in Italy has grown a lot, in terms of practitioners, especially with the advent of online trading, both in terms of quality. We must not forget that Italy has a great tradition and level all the times that an Italian was confronted with major worldwide technical analysis has always obtained excellent results. I remember the World Trading Championships with Andrea Unger, Riccardo Ronco at European level (by the way both will be keynote speakers) and even my personal experience as twice winner of the Leonardo of financial research award and recipient of the first IFTA John Brooks Award. MVG - The term “heretics of finance” was the nickname for technical analysts coined by Professor Andrew Lo, based on the fact that the academic world, in the beginning, saw Technical Analysis as a sort of alchemy. They thought that Technical Analysis was to financial analysis as astrology was to astronomy. Despite these first historical misgivings, a vast number of academics have studied Technical Analysis and have come to several interesting conclusions regarding its benefits and pitfalls. But many investment professionals are still very skeptical about Technical Analysis: Is it the same in Italy? FC - I would say that the pattern identified by Professor Lo has been followed in Italy in recent years. The first attempts to introduce technical analysis academically in Italy are likely to be found by some pioneers as my first professor Angelo Bertotti, who wrote a quantitative book in the mid ‘80s about technical analysis with Bocconi University’s professor, Andrea Fornasini. Since then, there has been

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a silent contradiction, in the sense that if on one hand the technical analysis was deemed as useless, on the other hand it was studied carefully, especially in its relation to behavioural finance and quantitative modelling. In fact, in recent years there has been an exponential growth in the interest in our discipline in the institutional side of asset management and in the academic world. One proof is the success of the institutional SIAT courses and special seminars. I think the most evolved part of technical analysis will be recognized at all levels in the future. MVG - It looks like the Italians, in general, are more interested in TA for short-term trading purposes than a more organic and structured approach. This is the main focus of most public events (conferences) that are held in Italy. Do you agree, or other aspects emerge despite the appearances? FC - It is true but this is not just an Italian phenomenon. The expansion in online banking and electronic trading made the TA popular worldwide. Many see it as an easy means of making money, but we all know that making money in the markets isn’t simple at all. The level of knowledge in technical analysis is quite diffused today but just among those professionals who are faced directly with the issue. MVG - In 2017 in Italy it is officialy born the register of financial advisors. Can technical analysis emerge from its peculiarity and be diffused among these investment professionals? FC - Definitively. Our association promotes the procedures for obtaining the professional recognition within the category. It is not an easy road but it is a road required for the, let’s call it “customs clearance”, of technical analysis. As President of the Scientific Committee of SIAT, I am personally involved in the improvement of the public image of Italian Technical Analysis. MVG - Let’s understand to which extent a deep training in Technical Analysis can open the doors to students into a professional future.What is your relationship with the academic world? FC - SIAT is pursuing relationships with the academic world with an unprecedented effort. We are trying to involve different universities and especially some professors who, by their nature or by their affinity for material on technical analysis, are open to the development of partnerships. The Milan IFTA conference will be the springboard for these initiatives as well as having several academic names, and we are studying the possibility of supporting a major experiment in behavioral finance that will take place at the same time and place as the conference. MVG - Are you planning something particular for the conference in Milan? FC - Yes. We are planning an IFTA 2017 Kickoff event that will take place the day before the start of the Conference, on 12 October, at the Italian Stock Exchange with full financial and non-financial media coverage. We will have a speech by Raffaele Jerusalmi, CEO of the Italian Stock Exchange; a Deloitte speech on Fintech; Fabrizio Plateroti

(Head of Capital Markets & Post Trading Regulation, Borsa Italiana) and Thomson Reuters that will speak on Mifid2; Frederic Leroux (nr 2 at Carmignac Gestion) about the human’s role in asset management; Neil Dwaine (Global Strategist, Allianz) on artificial intelligence; Denis Panel, CIO Theam (BNP Paribas) on behavioural finance. We are also planning a round table dissusion with Spyros Skouras, John Bollinger, Riccardo Ronco and Professor Sergio Focardi. We have also planned two events, one to promote IFTA with the financial media in early May and the other to promote it to the two largest independent financial organizations in Italy, in early June. MVG - How do you see the evolution of Technical Analysis worldwide in the coming years? FC - I think that the key challenge is credibility. We must break away from the image of financial alchemists and we must use its best technology and all branches of our discipline that have a scientific basis or that can be traced back to quantitative or behavioral patterns. As they say in many fields - “go big or go home”! MVG - Thank you, Francesco.

In the following pages I’m pleased to provide to our readers articles by five of the speakers from the upcoming IFTA conference in Milan.

Francesco Caruso will introduce us to his work about his contrarian indicator: the Fear/Complacency

Index. Professor Hank Pruden presents us with an article about the Wyckoff Method combined with the Elliott Wave Principle. We then have an interesting

article by Perry Kaufman about index and portfolio

construction and the first chapter of Bob Prechter’s

new book about the Socionomic Theory of Finance with a review by Prof. Pruden. Finally, Alberto

Vivanti gives us his thoughts about the construction process of a sector rotation strategy. Happy reading!

The Swiss Technical Analysis Journal • Spring 2017 • 7

Fear/Complacency Index (FC Index) Francesco Caruso, MFTA One of the Holy Grails of technical analysis is the search for tops and bottoms. Because it is an approach that has a lot of limits and exposes the operator more to disillusionment and damage than to successes and joys, there have been many attempts to find a solution, the best possible, in detecting excess situations, i.e. where it becomes statistically and objectively interesting to assume a „contrarian“ attitude (i.e. to buy or cover short at the hypothetical end of a downtrend, or to sell, profit or hedge at the top of a rally). The Fear/ Complacency Index, which owes its name to the two forces that move the markets from a psychological point of view, is a contribution in this direction.

Building logic

The Fear/Complacency indicator is based on price and the sequence of closes. It may in some respects resemble RSI, Williams% or stochastic, although it is actually softer than the first two and less dispersive than the third one. It also clearly indicates the overbought areas (between 85 and 100) and the oversold ones (between 15 and 0). The goal is to identify areas of potential reversal or risk/opportunity potential.

Display

CAC Index – Monthly data

Fear/Complacency Index (fear between 15 and 0, complacency between 85 and 100) – Arrows are automatically placed on the reversals in the indicator (big arrows on Major ovb/ovs peaks at 100 and 0, small arrows on Minor reversal between 100 and 85 and between 15 and 0).

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FTSE MIB Index – Weekly data

GOLD – Weekly data

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Interpretation

The Fear/Complacency Index is very simple in its construction and has a scale and interpretation not dissimilar to those of the RSI. This is an indicator that can overcome some problems in the same RSI, momentum, rate of change, or other such oscillators. These indicators generate significant complications in their interpretation, especially when there is a sudden movement in the market. Therefore, for a better and more comprehensive analysis, it is necessary to minimize these distortions on the one hand, and to highlight a precise and narrow band where it is possible to identify the excesses. In addition to solving this problem, the FC Index has a constant oscillation band, from 0 to 100, which allows a comparison of values at certain predetermined levels and the identification of the two overbought/oversold bands (between 85 and 100 and between 15 and 0). Strength points:

• simplicity of display; • identification of extremes and, therefore, of areas of risk/opportunity on an objective and clear scale;2 • possibility for the indicator to easily reach full scale (at 100 and 0) and, therefore, generate two different levels of signals (Major and Minor)

Use

The FC was built to identify only overbought/oversold areas over any time frame. The goal is to identify most of the pivot points and excesses (not obviously all, which is virtually impossible given the delusional nature of the markets) and therefore the potential turning points. The FC Index, therefore, indicates the areas where it is statistically appropriate to proceed to the clearance or reduction of positions or possibly to the opening of counter-trend positions. The Fear/Complacency Index is a quantitative and non-qualitative indicator: it identifies the setup for potential turning points, but does not in itself give any indication of the importance of the turning point or the potential of the next movement. The indicator has no optimization parameter and does not vary as a mode of use over any time frame.

Metastock formula

HP:=If((C-Ref(C,-1))>=0,(C-Ref(C,-1))/(H-L),0); LP:=If((C-Ref(C,-1))<0,(C-Ref(C,-1))/(H-L),0); PR:=HP/(HP+LP); FCST:=Sum(PR,3)/3*100; FCI:=(Mov(FCST,3,W)+FCST)/2; FCI

Francesco Caruso, MFTA, is the founder and owner of Market Risk Management, an investment advisory company that provides technically-driven money management services, and develops and provides proprietary research for institutions and individuals. He is member of the IFTA Board,Vice President of SIAT, the Italian Technical Analysis Society and President of the SIAT Scientific Committee and has been a speaker at IFTA 1998 (Rome), IFTA 2006 (Lugano) and IFTA 2016 (Sydney). He graduated in Economics at Bocconi University and since 1989 focused on the development and application of trading systems and quantitative analysis to asset management and asset allocation models. He published books and articles and created technical models and indicators, such as the Composite Momentum and the Fear/Complacency Index. In 2008 he became the first MFTA (Master of Financial and technical Analysis) in Italian history and was awarded the first IFTA John Brooks Award® for the best MFTA paper (“Technical Tools and Equity Selection: A Reward/Risk Rating Indicator for the Stock Market Components”, was also published in the 2010 IFTA Journal). He is also the recipient of the award “Golden Leonardo of Financial Research” in the technical analysis division (1997 and 1998) and recipient of the SIAT Award 2011 and 2015. Mr. Caruso is also advisor for funds and institutions and is involved in projects and courses regarding the diffusion of technical analysis. He is a visiting professor at the Cassino University and teacher in the Executive Master in “Quantitative and Technical Analysis of the Financial Markets”. www.cicliemercati.it www.compositemomentum.com

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Combining the Wyckoff Method and the Elliott Wave Principle in a Life Cycle Structure of Market Analysis: The present position and the probable future trend of US Equity Prices Henry “Hank” Pruden, PhD So DNA, which is in itself a kind of metaphor, is one more, and perhaps the ultimate, way to consider how markets possess a kind of life of their own. This is useful in encouraging the analyst to identify ever more basic structural components, how they interact, and ultimately to predict outcomes…

— Robert Miltner, Scientist, Chemist and Entrepreneur, Larkspur, California

The herd instinct is reflected by the S-shaped curve of the life cycle model, while the bell-shaped model shows how groups of market participants may be positioned and interrelated, ranging from the smart money to those who enter the market last. Together, the two form a cycle model that can be used to organize indicators to gauge technical market conditions and to predict crowd behavior.

Combining the Wyckoff Method and the Elliott Wave Principle in a Cycle Structure of Market Analysis: The present position and the probable future trend of US Equity Prices. — Henry “Hank” Pruden, PhD

— Hank Pruden, PhD

Figure 1: Markdown. The Life Cycle Model Wyckoff Method Combined with Elliott Wave The Swiss Technical Analysis Journal • Spring 2017 • 11

The Life Cycle Model can be used to combine the independent powers of the Wyckoff Method and Elliot Wave Principle. Together Wyckoff and Elliott forge a partnership that combines their strengths and offsets each other’s weaknesses. I offer the Life Cycle Model, a further refinement of the DNA metaphor combining Wyckoff and Elliott. A more detailed application shows the Wyckoff Method and the Elliott Wave Principle at work together over a bullbear market cycle.

The conceptual scheme that I apply in this presentation is based upon my “Life Cycle Model of Crowd Behavior,” which first appeared in the Technical Analysis of Stocks and Commodities magazine, 1999. I offer it as a further extension of the DNA metaphor combining Wyckoff and Elliott. The framework for combining Wyckoff and Elliott is The Life Cycle of Crowd Behavior (see figure 1). The reward of combining Wyckoff and Elliott is in the confirmation of one theory by the other. Those cross validations can be drawn from the price and volume structure (patterns) and from the counts of waves and price objectives. Let’s start with the pattern formation under the Wyckoff Method (consult figure 1).

Figure 2:

Schematic of the Wyckoff Method. It is a drawing of the price action depicting the Key Wyckoff Stages of Accumulation, Markup, Distribution, and Markdown.

Figure 3:

Schematic of the Elliott Wave Principle. Figure 3 is an assembly of Elliott Wave Principle cycles in three different degrees of refinement, thus wave 1 in the first level, top schematic that is the first of five waves found in a bull market. Wave 1 in turn is composed of another five smaller wave bull movements, illustrated immediately below it. The third level schematic is in turn sub-divisible into 21 sub waves that reflect the five wave bull movement of the immediate higher degree. Source: R.N. Elliott, “The Basis of the Wave Principle,” October 1940, Wikipedia

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Figure 4.

Life Cycle Schematic, Accumulation Phase.

Figure 5.

Life Cycle Schematic, Markup Phase.

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Figure 6. Life Cycle Schematic, Distribution Phase

Figure 7. Life Cycle Schematic, Mark-Down Phase.

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Figure 8.

DJIA bar chart for Future Projections. Source: BigCharts

Figure 9.

DJIA Point-and-Figure Chart with Price Projections, 2014. Source: PubliCharts.

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Figure 10.

Crowning Formation. During a classic crowning formation like this one, volume expands and prices oscillate between a support and resistance level. A few stocks record dramatic price gains.

Figure 11.

INDU. Point-and-Figure Pattern. Double Top Breakout. Source: StockCharts

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Figure 12.

Dow Jones Industrial Average, past twelve months. Bar chart for Future Projections.

Source: BigCharts

Figure 13.

Connect the Dots. Three-Scenarios Trend-Projections Exercise. A = current position of the market. B, C, and D are the expected or possible end points for each of your scenarios. There are expected/potential terminal points for each of your three scenarios. Look out 12-36 months from now. Draw in a line chart approximating what you think would/could happen to the price under each of your scenarios. Which do you believe is the most likely? Second most likely? Least likely scenario? Use the below figure to illustrate your scenarios.

Henry O. (Hank) Pruden, Ph.D. is a Professor of Business and Director of the Technical Market Analysis Program at Golden Gate University, San Francisco, CA, USA. He is also a Chairman of the Technical Securities Analysts Association of San Francisco (TSAASF). Hank is an honorary member of SAMT. www.hankpruden.com

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Get Higher Returns When You Create Your Own Sectors Perry Kaufman According to the advertising “Why trade one healthcare company when you can trade them all?” It’s a good line and it avoids trying to decide which companies to trade. On the other hand, trading all the healthcare companies includes some that are “not-so-good” and puts more risk on the large caps. The SPDRs ETFs weren’t intended to maximize your returns or reduce risk, just to track an industry. If you’re looking for profits, you can do much better. Capitalization weighting, the way the S&P is calculated, is the way most sector ETFs are constructed. If you want to extract the piece of the S&P that is exactly like the S&P, they have it right. But that doesn’t mean it’s the best way to make money. After all, they are interested in an index, while we’re interested in profits.

Correcting Two Problems

We’re going to make two simple changes to the SPDR sectors, using Healthcare (XLV), and Energy (XLE) as examples. Choose the fewest stocks that represent 50% of the weighting of the index, and ignore the rest.

Chart 1. Healthcare components in order of descending weight. Source: www.sectorspdrs.com

Weight them equally, that is, invest the same amount in each of the stocks The reasoning behind this is that stocks with the largest weighting have the greatest impact on performance. If the top few healthcare companies post big losses, then it hardly matters what the rest of the sector does, you’ll end up with a loss. That’s not the way diversification should work. Each stock should have the same risk and should contribute equally to the returns.

Over-Diversification

Adding more and more stocks to your index, or your portfolio, will gain some

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diversification, but less and less. In addition, the first stocks chosen are usually the best, and adding more gives you marginal returns, which lowers overall performance. Picking a few of the best is better than trading a large number of stocks. In the case of the Sector SPDRs, the largest cap stocks are not necessarily the best performers, but we’ll use them anyway to show how this works.

Table 1. Nine largest Healthcare companies representing 50% of the XLV index.

Healthcare (XLV)

The Healthcare sector has 57 components, which change from time to time. Chart 1 shows the distribution by weight. As you can see, more than half of them have weights less than 1%. We’ll take the top 9 companies representing 51% of the index, beginning with JNJ, shown in Table 1. That makes a manageable number of stocks and allows a small investor to participate, by buying $1000 of each stock.

In Chart 2 we see that an equally-weighted portfolio (each stock gets the same initial exposure) of the 9 largest stocks consistently outperforms XLV. A quant might argue that there is some ex poste selection here, that is, the largest cap stocks may be the ones that have outperformed others. If that were true, then XLV, which weights those more, would outperform our new portfolio. As we can see, the equally-weighted portfolio gains steadily over XLV. Looking at the statistics, XLV had a 15.9% return with almost the same volatility, giving an information ratio of 1.021. Our new portfolio had a return of 22.0%, volatility of 18.1%, and a ratio of 1.215, a nice improvement.

Table 2. XLV versus a portfolio of the largest 9 equally-weighted stocks.

Chart 2. Comparison of Healthcare (XLV) and an equally-weighted portfolio of the largest 9 healthcare stocks.

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XLE, the Energy ETF

To put aside the idea that XLV was selected because it worked, we can also look at the energy sector, XLE, which is both volatile and well off its highs. For this sector we’ll choose the largest 8 stocks, comprising 60% of the index, shown in Table 3. We chose eight stocks here because the top 50% would have been only five stocks, which would be marginal diversification. Table 3. Eight stocks representing 60% of XLE.

Chart 3. Comparison of Energy (XLE) with an equally-weighted portfolio of the 8 largest energy stocks.

By equally-weighting these stocks we get results shown in Chart 3 and the statistics in Table 4. The equally-weighted consistently outperforms XLE. For this sector the returns are much lower than healthcare, but the equallyweighted portfolio shows a similar advantage over XLE.

Table 4. XLE versus a portfolio of 8 largest energy stocks.

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The Main Points

The sector SPDRs were never intended to improve returns of those sectors, simply to isolate various industries as benchmarks. A portfolio that is capitalization weighted means that the largest cap stocks must perform best for an investor to capture the best returns. That rarely happens. Using a large number of stocks correctly isolates the industry performance, but those companies with the smaller weights don’t contribute much and more likely cause over-diversification when viewed as a portfolio. Investors interested in trading a sector should look first at an equally-weighted portfolio of a small number of very liquid stocks. As shown with healthcare and energy, they will most likely significantly improve your returns.

Perry Kaufman is the author of Trading Systems and Methods and A Guide to Creating a Successful Algorithmic Trading Strategy. He has been the managing director and general partner of investment funds and the chief architect of their strategies. He is president of KaufmanSignals.com, a website that offers subscriptions to trading strategies and portfolios. He may be contacted via his website, www.KaufmanSignals.com, or by email at Perry@kaufmansignals.com.

The Swiss Technical Analysis Journal • Spring 2017 • 21

Book Review

The Socionomic Theory of Finance Henry “Hank” Pruden, PhD This prodigious piece of work (813 pages) encompasses a new school of thought that proposes to more accurately explain the behavior of financial markets. Building upon scientific, empirical observations plus theories and findings from psychology and the social sciences, Mr. Prechter presents a comprehensive theory that is intended to displace the efficient market hypothesis and kindred economic models. The implications of this endeavor by Mr. Prechter are profound for students and practitioners of financial markets. At the base of The Socionomic Theory of Finance is the thesis that financial markets, such as the Stock Exchange, are a manifestation of “Unconscious Herding Behavior.” Hence, financial market trends and patterns are a reflection of endogenous herding behavior. Changes in market trend direction occur because of changes in social mood. A swing in mood, say from optimism to pessimism radiates throughout the financial community to shape herd behavior. The price, volume, and sentiment measures of markets follow in an orderly, predictable fashion according to a hierarchy of fractals and the structure of the Elliott Wave Principle. Mr. Prechter buttresses his main thesis that market behavior is a manifestation of herd psychology in action through a careful and comprehensive critique of earlier and recent thought in economics, psychology, and social sciences plus practitioners’ observations and actions. Aiding Mr. Prechter in his endeavor are excellent contributions by Alan Hall, Brian Whitmer, Wayne D. Parker, Wayne Gorman, John R. Nofsinger and Kenneth R. Olson. All of those contributions appear in this book by Reobert R. Prechter. I am convinced that both students and practitioners in financial markets will discover these brilliant excursions by Prechter et. al to be intellectually broadening, financially rewarding and in many cases entertaining. In sum, The Socionomic Theory of Finance by Robert R. Prechter is an important book and a worthwhile purchase. The Socionomic Theory of Finance by Robert R. Prechter published by the Socionomics Institute Press, Gainesville, GA, USA ISBN: 9781540510433 Copyright 2016 Robert R. Prechter

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The Myth of Shocks

An Excerpt from Chapter 1 of The Socionomic Theory of Finance Robert Prechter Few people find a new theory accessible until they first see errors in the old way of thinking. Part I of this book challenges the universally accepted paradigm under which humans’ rational reactions to exogenous (external, or externally generated) causes purportedly account for financial market behavior. The current chapter explores whether dramatic news events affect financial markets.

Testing Financial-Market Reaction under Perfect Conditions

In the physical world of mechanics, action is followed by reaction. When a bat strikes a ball, the ball changes course. Most financial analysts, economists, historians, sociologists and futurists believe that society works the same way. They typically say, “Because soand-so has happened, it will cause such-and-such reaction.” This mechanics paradigm is ubiquitous in financial commentary. The news headlines in Figure 1 reflect what economists tell reporters: Good economic news makes the stock market go up; bad economic news makes it go down. But is it true? In the second half of the 1990s, a popular book made a case for buying and holding stocks forever. In March 2004, after several terrorist attacks had occurred, the author told a reporter, “Clearly, the risk of terror is the major reason why the markets have come down. We can’t quantify these risks; it’s not like flipping a coin and knowing your odds are 50-50 that an attack won’t occur.”1

Figure 1

Good economic news propels markets – USA Today, January 15, 2004

Bad economic news is chilling investors

In other words, he accepts the mechanics paradigm of exogenous cause and effect with respect to the stock market but says he cannot predict a major cause part of the equation. The first question is, if one cannot predict causes, then how can one write a book predicting effects? A second question is far more important: Is there any evidence that dramatic news events that make headlines, including terrorist attacks, political events, wars, natural disasters and other crises, are causal to stock market movement? Suppose the devil were to offer you historic news a day in advance, no strings attached. “What’s more,” he says, “you can hold a position in the stock market for as little as a single trading day after the event or as long as you like.” It sounds foolproof, so you accept. His first offer: “The president will be assassinated tomorrow.” You can’t believe it. You are the only person in the world who knows it’s going to happen.

The devil transports you back to November 22, 1963. You quickly take a short position in the stock market in order to profit when prices fall on the bad news you know is coming. Do you make money? Figure 2 shows the DJIA around the time when President John F. Kennedy was shot. First of all, can you tell by looking at the graph exactly when that event occurred? Maybe before that big drop on the left? Maybe at some other peak, causing a selloff?

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– The New York Times, July 15, 2012

Figure 2

Figure 3

The first arrow in Figure 3 shows the timing of the assassination. The market initially fell, but by the close of the next trading day, it was above where it was at the moment of the event, as you can see by the position of the second arrow. The devil had said that you could hold as briefly as one trading day after the event, but not less. You can’t cover your short sales until the following day’s up close. You lose money.

You aren’t really angry because, after all, the devil delivered on his promise. Your only error was to believe that a presidential assassination would dictate the course of stock prices. So, you vow to bet only on things that will directly affect the economy.

Figure 4

The devil pops up again, and you explain what you want. “I’ve got just the thing,” he says, and announces, “The biggest electrical blackout in the history of North America will occur tomorrow.” Wow. Billions of dollars of lost production. People stranded in subways and elevators. The last time a blackout occurred, there was a riot in New York City, causing extensive property damage. “Sold!” you cry. The devil transports you back to August 2003. Figure 4 shows the DJIA around the time of the blackout. Does the history of stock prices make it evident when that event occurred? After all, if market prices change due to action and reaction, then this surprise economic loss should show up unmistakably, shouldn’t it? There are two big drops on the graph. Maybe it happened just before one of them. The arrow in Figure 5 shows the timing of that event. Not only did the market fail to collapse, it gapped up the next morning. You sit all day with your short sales and cover the following day with another loss.

“Third time’s the charm,” says the devil. “Forget it,” you reply. “I don’t understand why the market isn’t reacting to these causes. Maybe these events you’re giving me just aren’t strong enough. What I need is a real shock.”

Figure 5

The devil leans into your ear and whispers, “Terrorists will detonate two bombs in London, leveling landmark buildings and killing 3,000 people. Another bomb planted at Parliament will misfire, merely blowing the side off the building. The planners will vow to continue their attacks until England is wiped off the map.” He promises that you can sell short on the London Stock Exchange ten minutes before it happens and even offers to remove the one-day holding restriction. “Cover whenever you like,” he says. You agree. The devil then transports you to a parallel universe where New York is London, the Pentagon is Parliament and the DJIA is the LSE. It’s a replay of September 11, 2001. Figure 6 shows the DJIA around that time. Study it carefully. Can you find an anomaly on the graph? Is there an obvious time when the shocking events of 9/11 show up? If markets react to exogenous shocks, as baseballs do, there would be something obviously different on the graph at that time, wouldn’t there? But there isn’t.

Authorities closed the stock market for four and a half trading days after the 9/11 attack, and it stayed closed over the following weekend. Was it certain that the market would re-open on the downside? No. Some popular radio talk-show hosts and administration officials advocated buying stocks on the opening just to “show ‘em.” You 24 • Spring 2017 • The Swiss Technical Analysis Journal

sit with your short position, and you are nervous. But you are also lucky. The market opens down, continuing a decline that had already been in force for 17 weeks. You cheer. You’re making money now! Well, you do for five days, anyway. Then the market leaps higher, and somewhere between one and six months later (see Figure 7) you become disgusted and confused and finally cover your shorts at a loss.

Figure 6

The devil spreads his hands in apology. “Wait! You saw how it worked for a few days! I can’t help it if you held on too long.” You start to walk away. He gives it one last shot. “I know. You need something that’s going to work long term. How would you like to take a long term trade that’s guaranteed in print?”

You hesitate. He says, “I happen to know of a devastating event that future historians will describe as ‘the costliest natural disaster in the history of the United States.’2 Does that sound promising?” You’re not sure. “Where is it going to hit?” “New Orleans will get the worst of it.” “Forget it. I can’t short New Orleans.” The devil smiles slyly. “No, but you can buy oil futures contracts. Hang on. Just read this future description of the effects of the event, which will be available on the Internet ten years after the fact.” He hands you this report:

Katrina shut down 95% of crude production and 88% of natural gas output in the Gulf of Mexico. This amounted to a quarter of total U.S. output. About 735 oil and natural gas rigs and platforms had been evacuated due to the hurricane. The price of oil fluctuated greatly. According to [a spokesman on the scene], “half billion dollars a day of oil and gas is unavailable. Hurricane Katrina will impact oil and gas infrastructure, not just short term but long term as well.” The storm interrupted oil production, importation, and refining in the Gulf, thus having a major effect on fuel prices.3

Figure 7

“C’mon!” he says. “You can’t get a better guarantee than that!”

You think, “He’s right. It’s there in black and white: ‘a long term impact... a major effect on fuel prices.’” This is the trade you’ve been looking for. You agree to go for it. The devil transports you back to the early morning of August 29, 2005, the day Hurricane Katrina hit shore. As soon as the market opens, you buy an armload of oil futures contracts. You sit back and wait for the outcome future historians had described. Figure 8 shows the day you placed your all-out bullish bet: August 29, 2005, right at a top in oil prices and just before a three-month slide of over 20%. You are stunned. A recordbreaking, surprise disruption in the supply of oil failed to make oil prices zoom. On the chart, it even looks as if somehow the event made prices fall. You are bewildered. You took Econ 101 in college, and the market’s reaction makes no sense. You finally sell out, taking a loss. You look into the history of the matter and come across a footnote on Wikipedia saying that President G.W. Bush had released oil from the U.S. Strategic Petroleum Reserve in the wake of Katrina. Maybe that was the devil’s secret! But, no. The U.S. was consuming 21 million barrels of oil a day at the time,4 and the Reserve over a period of weeks released only half a day’s worth.5 You pull out a historical chart of oil and discover that even in late August 2007, two years after the event, its price was exactly

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Figure 8

the same as it was on the day you had bought, even though oil was in the middle of a monstrous bull market in which its price soared over 1300% from 1998 to 2008. Somehow your purchase caught one of the few setbacks within it.

You do a Google search, and there it is—the passage the devil had read. The historians lied. They must have figured that a disaster of such magnitude simply had to have a major effect on oil prices, so they just said it did. Their devotion to exogenous-cause logic obscured their perception of history. You take a day off to do some research and come across an exhaustive, 40-year study of the impact of 177 large earthquakes on the returns of stock market indices in 35 different countries from January 1973 to August 2013. You read that despite limiting the earthquakes under study to those causing at least 1,000 fatalities or a minimum of $25 million in property damage, the authors were able to identify “No systematic effect of earthquakes on aggregate stock market indices, either directly or through the control variables.”6 Then you realize: This must go for assassinations, blackouts, terrorist attacks and hurricanes, too.

If you are an everyday thoughtful person, you decide that events are irrelevant to markets and begin a long process of educating yourself on why markets move as they do. If you are a conventional economist, you don’t bother.

Now think about this: In real life, you don’t get to know about dramatic events in advance. Investors who sold stocks upon hearing of the various events cited above did so because they believed that events cause changes in stock values. They all sold the lows or bought the highs. I chose bad news for these exercises because it tends to be more dramatic, but the same irrelevance attaches to good news.

Exogenous-Cause Claims Lead to Perverse Conclusions

Economists often say that an unexpected “shock” would cause them to reevaluate their bullish stock market forecasts. It does seem logical that a scary event such as a destructive terrorist attack, particularly one that implies more attacks to come, would be bearish for stock prices.

Take a moment to study Figure 6 again. Surely all of those exceptionally dramatic swings in the DJIA must have been caused by equally dramatic news: bad news at each of the peaks and good news at each of the bottoms. At least that’s what the exogenous-cause model would have us believe. Figure 9

As it happens, there was a lot of scary news during this time. Aside from the 9/11 terrorist attack on the World Trade Center and the Pentagon, there was also a slew of mailings of deadly anthrax bacteria, which killed several people, prompted Congress to evacuate a session and wreaked havoc lasting months. Where on the graph of stock prices in Figure 6 would you guess the anthrax mailings happened?

If you guessed, “the very day of a rally high and all through a four-month stock-price collapse,” befitting exogenous-cause theory, Figure 9 would vindicate you. It shows that the first anthrax attack occurred precisely on the top day of a rocketing advance that appeared destined to take the Dow to a new alltime high. The stock market reversed sharply and then fell throughout the period of attacks. When the attacks stopped, the decline stopped, and the market turned on a dime and soared. Good for you and exogenous cause theory! The only problem with your case is that Figure 9 is a lie.

Figure 10 tells the truth. The first anthrax attack actually occurred on the very day of the low for the year, after a dramatic, 18-month decline in the Dow. Afterward, despite six more attacks and public concern that more were in the works, 26 • Spring 2017 • The Swiss Technical Analysis Journal

the stock market rallied for six months. These attacks, deaths and scares, moreover, occurred throughout the strongest rally on the entire graph. To put it more starkly, the market bottomed the day the attacks started and topped out as soon as people realized they were over.

Figure 10

Figures 7 and 10 reveal an irrefutable fact: Terrorist attacks do not make the stock market go down. The assumption behind economists’ repeated implications that terrorist attacks would constitute an “exogenous shock” that would serve to drive down stock prices is simply wrong.

Since even possessing advance secret knowledge of highly dramatic, surprise events provides no advantage for speculating, guessing about coming events is an utter waste of time. There can be no causes related to external events that even the most prescient person could exploit. It gets worse. From the viewpoint of exogenous cause, Figures 3, 5, 7, 8 and 10 make it appear as if the assassination of President Kennedy was bullish, the New York City blackout contributed to a rally, Hurricane Katrina caused oil prices to drop, and terrorist attacks made stock prices soar. These conclusions are discordant and perverse.

People object, “You can’t tell me news doesn’t move the market. I see it happen every day!” But they don’t see any such thing, and it takes careful study to reveal that they don’t. Consider: If the market’s moves and the tenor of news were independently random, the two types of events would still fit each other half the time, wouldn’t they? That’s more or less what people see, and they expand those coincidences into what they think they see. As this chapter shows, the notion that exogenous shocks change market trends is highly suspect. Chapter 2 will broaden the scope of our investigation. As we will discover, a fundamentally different theory of social causality accounts for the chronology so as to turn discordant perversity into harmonic compatibility.

1 Shell, Adam, “Fear of Terrorism Jolts Stock Market,” USA Today, March 23, 2004. 2 Wikipedia, “Hurricane Katrina.” 3 Wikipedia, “Strategic Petroleum Reserve.” 4 “United States Crude Oil Production and Consumption by Year,” Index Mundi, indexmundi.com 5 Wikipedia, “Strategic Petroleum Reserve (United States).” 6 Ferreira, Susana and Berna Karali, “An Assessment of the Impact of Earthquakes on Global Capital Markets,” Annual Meeting of the Agricultural and Applied Economics Association. Minneapolis, MN. July 27-29, 2014

The above text is excerpted from Robert Prechter’s new book, The Socionomic Theory of Finance. For readers of The Swiss Technical Analysis Journal, the publisher is offering hardback copies of the book for half price ($US39) through the end of June 2017. For details, visit www.elliottwave.com/wave/STF-SAMT Robert Prechter is known for developing a theory of social causality called socionomics and for developing a new theory of finance. He is president of the Socionomics Institute, which studies social mood and its influence on financial markets, the economy, politics and cultural trends. Prechter and colleagues have written several academic papers, including “The Financial/Economic Dichotomy in Social Behavioral Dynamics” (2007) and “Social Mood, Stock Market Performance, and U.S. Presidential Elections” (2012), which became the third most downloaded paper on the Social Science Research Network that year.

The Swiss Technical Analysis Journal • Spring 2017 • 27

Some Thoughts About the Construction Process of a Sector Rotation Strategy Alberto Vivanti The field that attracts me the most in technical analysis, and is still the main object of my research, is the study of relative trends among assets, especially single equities or sectors, versus the market or region to which they belong. Sector indices enable investors to benchmark the performance of stocks in a specific industry and are today reproducible by employing the increasingly popular exchange-traded-funds (ETFs), through which it is possible to create dynamic portfolios. The investment criterion is well known, it is based on the assumption that the stocks, or sectors, that have performed better in the past, are poised to give better returns.

As a matter of fact, the construction of a sound portfolio strategy is not so easy and requires an accurate process of analysis and back-testing. I will describe some of the principle that I usually follow for this purpose.

Benchmark

When operating into a specific market, or geographical economic reality, we usually refer to a benchmark, an index that highly represents that markets, such as the S&P500 in the U.S.A or the Stoxx600 in Europe. Such indexes are segmented in sub-indexes regrouping stocks categorized by their primary source of revenue (sectors). Our purpose is to invest in these indexes, that can be replicated through the employment of specific market traded instruments (the ETFs). A market benchmark is that to which we refer when calculating the relative course of the sector but not in all the sectors-rotation strategies we need to calculate the relative trends against an index representing the market. One interesting methodology that I often use, compares the single trends of each sector in order to choose those that are supposed to be stronger. The algorithm does not need to include the market’s benchmark since we can compare the sectors among themselves. The benchmark will turn useful, and even necessary, as a reference for evaluating the results of our strategy.

Equal Weighting vs Capitalization Weighting

Most benchmark indexes are capitalization weighted, or market valueweighted. It means that the weights of their components depend on their total market capitalization. So, the larger components weigh much more than the smaller components. Such discrepancies are replicated by the sectors weighting. In the MSCI Europe, for example, the weight of financial sector is twice as much that of the consumer discretionary sector, and four times that of the technology sector.

Here is why, when calculating relative trends against the market, I rather employ an index that equally weights the sector indexes that contribute to its composition. Equal weighting prevents the imbalance caused by capitalization weighting.

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The chart in Figure 1 compares the Index MSCI Europe to a series derived by the equal weighting of ten underlying sectors since 1999. Each single sector weighs 10% thanks to a constant rebalance on a weekly basis. Its performance over the long run is better than the capitalization-weighted index, but this is not the issue. It could well happen the opposite if the heaviest sectors had outperformed instead of underperforming after so many years (this is the logical explanation of the performance spread), but leads me to conclude that calculating relative strength against an unbalanced benchmark may take misevaluations.

Relative Momentum

There are many ways to calculate Relative Strength. The most popular is the ratio between the two assets, by taking the price of one asset and dividing it by another. The number resulting from the operation is meaningless but it is the direction of the new price series that we obtain to be noteworthy. We can analyze it like any other chart, by studying its trend and applying indicators like moving averages, momentum and so forth, always considering that the result of our analysis will relate to the relative course. When we judge an asset as relatively stronger then we expect it to go better, or less worse, than the market, not necessarily go well.

Figure 1

The MSCI Europe (in red) compared with a constantly rebalanced equal weighting of its sectors components, since 1999. The latter performed a yearly compounded 5.5% against 4.5% because of the uneven sector weights of the MSCI Europe.

We can get to the same conclusions by calculating relative momentum. This is my favorite method, a difference between the momentum of the asset (sector in this case) and that of the benchmark, both calculated with the same parameters. A rate of change, rather than pure momentum, fits better because it is calculated as a ratio between the actual price and that of n periods ago, allowing, this way, to compare the returns among several time series in which figures can be totally different.

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Figure 2

The MS World Technology index since 2012 with relative strength against the World Index (red line). The spread between the rates-of-change at 12 weeks of both, sector and market index, is represented by the blue line. Values above zero for such spread reflect relative strength.

The chart in Figure 2 tracks the weekly data of the MS World Technology index (in US dollars) since 2012. The red line in the center window is its relative strength against the World Index. The blue line in the lower window represents the difference between the rate-of-change at 12 weeks of the sector and the same rate-of-change calculated on the benchmark. The difference has then been smoothed by a simple average at four weeks. Values above zero for such difference reflect relative strength. By comparing the courses of both the red and the blue line we can see that a rising trend of the ratio (red line) corresponds most of the time to positive values in the spread of rates-of-change.

Absolute Trends are not Less Important

Relative momentum helps to enhance the returns in the long run, but to reduce neither volatility nor drawdowns, especially in bear markets. A trend following method, based on the direction of absolute trends of sectors, for the determining the global exposure to the market, strongly increases the rewardrisk ratio of the investment by minimizing volatility without decreasing the profit potential. For this reason, my multi-sector strategies can’t do without an absolute trendfollowing component when the goal, as often the case, is that of reducing the volatility of the invested capital and the unavoidable sharp drawdowns that in a constantly fully-invested portfolio occur during bear markets.

30 • Spring 2017 • The Swiss Technical Analysis Journal

The chart in Figure 3 is that of the MS World Consumer Discretionary Index (in US dollars) since 2012, also with a spread between the rates-of-change of both, the sector and the World Index (blue line at the bottom of the chart). The red histogram on the top is a long-term trend indicator. The vertical lines show the occurrences when both indicators are positive. Investing in relative trends but only when the absolute trend is positive. This is a good to stay out of the sharp downtrends and the drawdowns that they produce.

Figure 3

The MS Consumer Discretionary Index since 2012. On the top (in red), a longterm trend indicator. On the bottom (in blue). At the bottom, the spread between the 12 weeks of both, sector and market index. Values above zero for such spread reflect relative strength.

Alberto Vivanti, Independent analyst, founder of Vivanti Analysis in 2003. He is a technical and quantitative analyst since the early 1980s, with a sound experience as an asset manager with Swiss Institutions. Author of a technical newsletter, lecturer for institutions and instructor in Technical Analysis courses in Switzerland for the IFTA Certification, author of articles and books, he has been co-author of a book with Perry Kaufman. Alberto chaired the IFTA conference held in Lugano in 2006. He has been a speaker at the IFTA Conferences 1998 in Rome and 2006 in Lugano, in 2017 in Milan. Alberto is Vice President of the Swiss Association of Market Technicians, representing the Chur and Liechtenstein Chapters.

The Swiss Technical Analysis Journal â&#x20AC;˘ Spring 2017 â&#x20AC;˘ 31

Geneva: High-Level Networking Opportunity for Financial Professionals Mario Valentino Guffanti, CFTe The third edition of Findating, will take place on 22 June 2017 in Geneva. This prominent event, is organized by FinLantern, the company that has managed another wellknown annual meeting held in Lugano since 2011: the Lantern Fund Forum. Also, Geneva’s Findating concept of financial networking is aimed at asset managers, private bankers, family officers, wealth managers and investment professionals.

In order to facilitate networking, FinLantern has created the “FinLantern Community”, reserved for all the participants at this event and totally free. The “FinLantern Community” is not the usual community where you can contact other profiles in a virtual world with a low probability of developing business with them effectively: all the members of this Community can meet each other in the real world during the Findating event, and you can imagine that the possibility to send messages to them, in

3rd edition

order to arrange meetings, could be very effective and useful.

The event will finish with a dashingly chic soirée. A very special Geneva Forex Event will be organised by Dukascopy, featuring an exquisite after-business party with also an exclusive fashion show sponsored by Vannina Vesperini. This year the event will be focused on Fintech, with a special attention to the blockchain technology and new Swiss Regulations in this field. For information on participating in Findating 2017, please visit their website.

The Swiss Association of Market Technicians (SAMT) is an event partner and all our members can participate. For a preview, we are publishing an interesting article about Bitcoin, written by Giacomo Zucco, one of the main speakers at Findating 2017.

22th June 2017 The high-level Financial networking

in GENEVA

Organized by

@FinancialDating Geneva Finance Group

www.FinDating.com

32 • Spring 2017 • The Swiss Technical Analysis Journal

Eight Widespread Misconceptions About Bitcoin Giacomo Zucco With its price touching all-time-high these days, Bitcoin is something many traders and analysts are looking at with interest. While trading bitcoins (and other “altcoins”, i.e. bitcoin clones with some distinctive features) is extremely easy, due to the lack of any kind of significant entry barrier, successfully performing technical analysis on this market is not trivial at all. One reason for this is, of course, the very small dimension of the analyzed target (small market cap, insignificant market depth, concentration of wealth in the hands of few “whales” that can easily move the market, early and changing regulatory and economic environment, etc.), but another important reason is the inescapable difficulty that analysts find in giving at least a very general and broad “fundamental” frame, in the context of which develop technical analysis. Bitcoin is a complex and strange beast: to properly understand its goals, characteristics, origins, potentials and implications, one has to master many distinct and specialized fields like applied cryptography, distributed systems engineering, game theory, software development, monetary policies. But even without the need to become experts, there are certain myths and misconceptions, widespread and strongly maintained by almost all mainstream publications, that could be easily avoided with some research. In this article, I would like to debunk 8 of the most common misconceptions about Bitcoin, that could potentially lead to a deep misunderstanding of the phenomenon and the market.

1.“Bitcoin is like a company, or a product”

Accustomed as we are to product-based and companybased technology innovations (Google, Apple, Facebook, Tesla, WeChat), it seems natural to many to consider Bitcoin through this kind of interpretation. Nothing could be further away from the reality of the phenomenon. Bitcoin is an infrastructure-level open standard, like the Internet itself, or like the eMail protocols. Many talk about bitcoin as a company (there have been many hilarious news in mainstream media with titles like “Bitcoin’s CEO arrested”), or as a product, which is heavily misleading. Market dynamics operate in very different ways for open infrastructural protocols and for commercial products. Products can be easily replaced, surpassed, modified, forgotten, while technical open infrastructure-level standards, when they succeed, are extremely difficult

to change or replace. Companies and products will be developed on top of Bitcoin infrastructure, but Bitcoin itself is something completely different. Many Bitcoin companies, even very big ones, have gone bankrupt, have failed, have been hacked and robbed, but the protocol itself is sound and safe, protecting wealth stored in it constantly since 8 years now, even if under constant attack. Rather than thinking of Bitcoin as a product released by a traditional corporation, it is more appropriate to think of it as a self-sustaining digital commodity, similar to gold. It has a healthy satellite industry that provides products and services based around it, and it has its own business and advocacy organizations, but there is no central Gold Corporation. The databases that show Bitcoin addresses with a given bitcoin balance are all collectively managed by the network using a peer-to-peer network, similarly to the peer-to-peer networks used by file sharing services. Also: while personal vicissitudes of Elon Musk could affect Tesla in a significant way, that’s not the case for Bitcoin: the code of the protocol is there, open for anyone to read, review and study, almost impossible to modify (but in the unlikely case of a plebiscitarian active agreement between every single entity who is now running a node). During the age of Internet development, few analysts were aware of the name of the inventors of the technology, and that was not even considered relevant, while many today think that the real-world identity of “Satoshi Nakamoto” (Bitcoin’s pseudo-anonymous creator, or creators) is important to understand the phenomenon: it’s not. Whoever analyzed the “.com bubble” thinking at the World Wide Web as a single company, or as a commercial bubble, would have had a hard time in making sense of the market data.

2. “Bitcoin is used by criminals, so it will be probably illegal”

Bitcoin has a strong reputation of being used «only by criminals», thus leading someone to think there are strong probabilities of a global ban on this technology. This is expecially true after the recent wave of “ransomware” attacks (ie the infamous “Wannacry”), using the protocol as a payment system for the ransoms. The cryptocurrency first came to public attention in 2011 as the payment method for Silk Road, an online black market for illegal drugs, fake IDs and other illicit goods and services. When FBI shut down Silk Road and apprehended its alleged creator, the price of Bitcoin dropped sharply but quickly

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recovered, and yet, even since that bust, the media has no special meaning. We say that there will be only “21 lost no opportunity to tie Bitcoin to Silk Road in report millions of bitcoins” in circulation (since the supply is after report. Journalist Lewis Sanders IV had to publicly strongly fixed once for all by the protocol), but it would apologize, after launching the “news” of the use of Bitcoin be the same to say that there will be only “21 billions of by the Islamic State: the news was further denied by milli-bitcoin” in circulation. When someone says that Europol, but it is still in circulation. This “Bitcoin surpassed the value of Gold”, is not new: almost the same was said of that’s heavily incorrect: while a single the Internet itself at the beginning of its bitcoin is now more valuable than a The whole Bitcoin adoption. Even ignoring the fact that any single gold ounce, that would not be true economy is now little technology can be used for crime (cars are anymore if we considered grams instead used for bank robberies every other day, of ounces, or “micro-bitcoins” instead of above $36 billion. but this is not considered a good reason “bitcoins”. The only significative measure to ban them and return to the carriages), Accounting is easy: there is would be to compare Bitcoin’s market and even by labeling as “criminal” any no space, in Bitcoin market cap with overall physical gold market activity that a certain political regime cap: if we did that, we would see that cap, for even a very small there’s still a long road to go for Bitcoin forbids (hence not only indisputably evil things like “international terrorism”, but in order to actually “surpass Gold”. At part of relevant illegal also: poor Afghan women who want to the same time, it doesn’t make any sense activity. work and get payed outside the system, to state that a 21 millions supply is “not Venezuelan families who want to protect enough”: if needed, the whole global its life savings from inflation, immigrants, economy could be accommodated in refugees and underage people who want to receive and those 21 millions, provided that we use submultiples, move money but have no access to bank accounts, people and that the price of the units goes up enough. A single with strong civic sense who want to donate to Wikileaks for bitcoin, by the way, is not “too much expensive” at current more transparency on illegal government activities, etc.), price: a $36 billion US market cap is very little if compared still numbers don’t add up. The world’s illegal economy is with other potential benchmarks (physical gold itself for estimated at around 22% of global GDP. The whole Bitcoin store of value and inflation-hedging functions, VISA/ economy is now a little above $36 billion. Accounting is Mastercard/Paypal volumes for online payments, USD easy: there is no space, in Bitcoin market cap, for even a cash for grey and informal markets, etc.). very small part of relevant illegal activity. If, for example, 4. Bitcoin is “controlled by China” Bitcoin was used today for a series of significative moneylaundering operations (which usually happen through Bitcoin “mining” activity is now concentrated in China the banking system), its value should be greater of many (possibly more than 70% of the computing power magnitude orders. To be precise, the whole Bitcoin market dedicated to this process is now delivered inside that cap is less than 0.15% of the estimated illegal and irregular country). It was concentrated in the US during the economy, less than 0.18% of the irregular economy, less first 4 years of life of the system (with peaks of more than 1.15% of the illegal economy. What we are left with is than 90% of the computing power), but that was never some exchange of illegal drugs on the deep web and some perceived as as serious problem. For some reasons, many “ransomware”: something estimated around few million now conflate this geographical concentration (which dollars in total. The safe choice for illegal activity, right has many explanations: cheap electricity coming from now, are US dollars. Often moved, stored and laundered oversize government-funded hydroelectric operations, by regulated banks (see, for a recent example, the billions close contact with chip producers, centralizing effects of of dollars laundered by Well’s Fargo’s subsidiary from the Internet “Great Firewall”, etc.) with a direct control Mexico’s murderous drug cartels). Also, it is extremely over the protocol by “the Chinese”. Bitcoin is actually unlikely now that Bitcoin could be ruled “illegal” in many the product of subtle checks and balances, the output of a common-law countries, after several auctions in which resilient (even better: “anti-fragile”) equilibrium between law enforcement sold on the market bitcoins seized from many forces, none of which can impose anything on the people and groups under arrest. others. One of these forces is represented by the “notaries” of the system, called “miners”, whose role is, if crucial, 3. “One bitcoin is now too expensive also very limited: to collegially establish a unique relative supply is too limited” chronology of the transactions. If a single player controlled There is this die-hard meme about one bitcoin being the majority of the mining calculation power, the worse “too expensive”. Since the value of Bitcoin has reached he could do would be to spend his own money twice a high of about $2,200, buying an entire Bitcoin would (and never others’ people money) or slow down others’ be so prohibitive that it would not be practical for use transactions, and even these attacks would be very easy as a currency. One of the main features of the Bitcoin to find, so they could be used one-off. Miners cannot alter protocol is the extreme divisibility of every single unit. the protocol rules, enforced by every single node of the It is possible to buy, sell or exchange even a very small system. The ultimate proof that bitcoin is not controlled by portion of what is commonly known as “a bitcoin”: the miners (much less by Chinese miners, or “China” itself) is way the unity is defined is completely arbitrary, carrying that even when a majority of them wants to change rule of 34 • Spring 2017 • The Swiss Technical Analysis Journal

the current Bitcoin protocol (like it’s happening right now, in the context of the so called “block-size debate”), that’s not possible without plebiscitary consent of every other player involved in the system (full nodes, exchanges, wallet providers, users, etc.).

bring to frauds and chargebacks, causes the transaction to be really “settled and cleared” only after many days, and with significant costs...but it’s mostly a social, political and regulatory problem, not a technological one. Millions of transactions could be processed in a second without significant problems, in these kinds of database. In 5. “The underlying technology is interesting, Bitcoin, even if the network is not running at full capacity, not the asset” a transaction takes almost an hour to be finalized, and Mainstream media, along with financial incumbents, like the cost is of several dollars for every single registered to repeat that “Bitcoin is not important, but the underlying operation (the transacting party will pay only a small part technology, called blockchain, is”. That doesn’t make of this cost, with “transaction fees”, while the most part any sense, since the entire architecture of a “blockchain” of the cost will be payed by all the holders with “inflation system relies on the existence of a financial incentive for tax”). If the network is congested (as it will likely be most of the mining process, thus on the existence of a native digital the time, predictably), costs and waiting times for a single transacting party raise even asset. Also, many of the typical more. The Bitcoin network, right limitations and shortcomings of now, is capable of processing a this tech, only exist because of There has certainly been few real-world little more of 3 transactions for Bitcoin’s particular assumptions: a global, permissionless, uses of this technology, so far, to create new second. They could get to 14 or 16 transactions for second, with trustless, open system. This is tools in order to manage, transmit, store, some optimizations, but more not new at all. During the ‘90s, sell, buy or register “traditional” financial than that would heavily hurt the telco incumbents were strongly security and the decentralization opinionated about the point not assets, like stocks, bonds, commodities, of the network. Of course, being about “the Internet” itself, government-issued currencies. adding this technological but in general about “online limitations to the “social” ones, technology” (often declined as using a bitcoin-like system “private permissioned intranets” or “wallet gardens”). Now, financial incumbents are inside the trust model and the regulatory environment of mainly negative toward “the Bitcoin” itself, but inexorably traditional financial structures, would just be like taking bullish about “blockchain technology” (often declined the worst of two worlds. That said, there is actually the as “private permissioned ledgers”). The narrative will possibility, for Bitcoin, to scale to millions of transactions turn, as it did for the Internet. There is no significative for second (mostly free and instant) without loosing most “online without Internet”, as there is no significative of its typical features, with technical structures called “blockchain without Bitcoin”. There is hardly any use of “payment channels” and “lightning networks”. But even the “blockchain technology” outside moving and storing with these future evolutions, a decentralized, redundant, bitcoins (one of these use could be trustless notarization of trust-less and open system will never be, ceteris paribus, data, using the Bitcoin blockchain as an “anchor”). There as cheap and as fast as a centralized and permissioned has certainly been few real-world uses of this technology, one, technologically speaking. so far, to create new tools in order to manage, transmit, 7. Bitcoin is “encrypted” and completely store, sell, buy or register “traditional” financial assets, anonymous like stocks, bonds, commodities, government-issued currencies. On the other hand, there could be a lot of The fact that Bitcoin was invented having financial uses of “traditional” financial tools (like ETFs, custodian privacy as one of its main goals, coming from a cultural banks, funds, regulated exchanges) in order to manage, (and political) environment deeply interested in privacy, transmit, store, sell, buy or register new blockchain-based anonymity, confidentiality, encryption, plausible assets, like bitcoin itself. deniability and so far, brings many to think that it’s a particularly “private” system. Some mainstream 6. “Bitcoin’s technology is cheap, fast, efficient” resources arrive to define it “completely anonymous Technically speaking, the underlying technology of Bitcoin money”. It is not. Even if somebody uses Bitcoin for is particularly expensive, slow and inefficient. And that’s anonymity purposes, the current nature of the protocol by design, and due to a trade-off with other characteristics is not very confidential or private: the way in which the of the system (“trustlessness”, “permissionlessness”, etc.). blockchain work is publishing every single transaction Only a complete misunderstanding of the technology, on the common, global ledger, accessible and queryable made easy by its exotic and complex nature, could lead by anyone with an internet connection, forever, without almost all mainstream commentators to reverse the any chance to delete or ament the history of an user. narrative completely. In traditional financial databases, And every transaction is chained to the others, in a way a transaction can reach a final, determined and verified which is usually very easy to track and follow, in order state in milliseconds, and this operation is virtually to connect “pseudonymous” addresses with real-life without any cost. The fact that financial institutions are persons, using forensic techniques. That could be seen heavily regulated, and that the trust model can easily as the very opposite of privacy and anonymity, indeed. The Swiss Technical Analysis Journal • Spring 2017 • 35

Another side of the misconception is probably just terminological: everyone knows that Bitcoin is based on “cryptography”, and usually this scientific discipline is associated with “encryption”. But in Bitcoin, actually, nothing is encrypted at all: cryptographic functions are used instead to sign transactions and to verify signatures, as well as to solve and verify cryptographic puzzles (“Proof of Work”). That’s another reason for which Bitcoin use for illegal activities is seriously overstated by mainstream media (see misconception number 2). Actually, many experts around the world are actively looking for ways to improve Bitcoin’s confidentiality (just some names as example of this innovative research trends: Coinjoin, JoinMarket, Tumblebit, Mimblewimble, Confidential Transactions, zkSNARKS, etc.), and some of the most promising scalability solutions (i.e. Lightning Network, see misconception number 6) are privacy and fungibility solutions as well. But Bitcoin is one of the most easy to track financial systems in existence so far. And its anonymity is often as weak as the regulated gateways to get in and out of the system, buying and selling the asset.

8. “There could be numberless competing clones of Bitcoin, and there are actually more advanced alternatives”

Provided that there is very little of interest, from a technological point of view, in current experiments about “private permissioned blockchains without a native digital asset”, one could think that, anyway, a number of other “public permissionless blockchain with a native digital asset”, such as Bitcoin, could co-exist for an indefinite amount of time in mainstream adoption. If that was the case, it would be false that there is really a strong cap on the total issued amount of this new kind of asset: alternativecoins would de-facto dilute existing coins as a kind of inflation, without a clear predictable limit. In reality, that’s probably not how this kind of infrastructures works. First of all, the mechanism underpinning the “mining” process, that characterizes Bitcoin’s design, is strongly subadditive: the overall security of two blockchains, with a certain about of computational power each, is way lower than the security of a single blockchain with the sum of all that hashing power. “Proof of Work” mechanism shows overwhelming incentives to converge on a single system. Also, Bitcoin shows very strong “network

effects” of these kind, that make really difficult, for any possible alternative, to contend the place of the “first comer”. Market cap, merchant adoption, development mindshare: these are all example of dynamics guided by network effect. Many of the difficulties in understanding this point probably originate from the confusion between an infrastructure-level open standard and a commercial product (see misconception number 1): since it’s natural to see specific products and services suffering competition and eventually being replaced, the same could appear to be applicable to Bitcoin, but that’s a fallacy. To give an easy example, consider the (in)famous Facebook-based game Candy Crush Saga. It was a success, but how hard would it be to eventually replace it, for other, superior Facebookbased games? Not really, actually. But it would be harder to replace the Facebook platform itself, on top of which the game is based, even with a slightly better alternative (not impossible, though: we can for example remember the story of MySpace, replaced by Facebook). It would be way harder to replace the World Wide Web platform, on top of which Facebook is based. And even harder to replace Http protocol, on top of which the WWW was based. The probability of modifying the TCP-IP protocol, underpinning the Http, is close to zero in the foreseeable time-frame (actually, even trying to “replace” its current version, IPv4, with a new improved version, IPv6, is taking decades and it turned out to be quite difficult). Bitcoin is not Candy Crush Saga...bitcoin id the TCP-IP of money. That means that it would be very hard to replace it, even for better alternatives (or for better versions of itself). That said, it would be not true, by any technical parameter, to state that “better alternatives” are available right now. Some clones of Bitcoin have been launched with different choices and different trade-offs that still have to prove to be “better” (for example: Litecoin adds some speed giving up decentralization, Ethereum adds some expressivity giving up predictability or scalability, Zcash adds some privacy giving ups almost everything else, etc.). Furthermore, these specific “improvements”, even if considered as such, are always developed by a small group of engineers, absorbing all the focus at the expenses of the overall security of the system. There are not (yet) significative alternative to the Internet, and Bitcoin is the Internet of Money.

Giacomo Zucco is a Theoretical Physicist, former Technology Consultant for Accenture spa, serial entrepreneur in the field of emerging technologies. Economic blogger and contributor to several Italian newspapers. Involved in several projects in Bitcoin and blockchain space since 2012, he is now CEO of Swiss-based research/developement/incubation/consulting firm BHB Network, a world-class competence center in the field.

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Monetary Policies and the Current Juncture Paolo F. Musto One analysis tool our readers can find both useful and easy to find even in common software like MS Excel, is the standard deviation. Let’s see how this can help to get a view on the current state of affairs of the Swiss real estate market. Figure 1 shows the UBS Swiss Real Estate Bubble Index, which indicates the risk of a real estate bubble forming on the Swiss housing market with +1 and -1 standard deviations marked with a dashed red line. This index is conveniently expressed in terms of z-scores. This basically means standard deviations. So our readers do not need to perform any calculations since a reading of +1, for instance, it means one standard deviation above the mean, +2, two standard deviations above the mean, and zero at the mean. As we can see, moves beyond +1 and -1 standard deviations (marked in the graph with dashed red lines), are not sustainable and at some point they revert. At the moment, we see the index is approaching 1.5 standard deviations. Let’s look at this from another point of view to see if we can get more clues regarding potential risks building up in the sector. Figure 1

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Figure 2

Figure 2 shows the UBS Swiss Real Estate Bubble Index along with an “oscillator” constructed by combining Real Estate with interest rates (the 10year rate). The rationale is that since most real estate investments are financed with loans, if loans become more expensive, the market cools off and prices could decline. Vice versa for declining rates, let’s see if such an “oscillator” can be useful to invest in the Swiss Real Estate market. We can see that once the oscillator goes above one and then crosses below it (red dashed line), the Real Estate market becomes vulnerable to a down turn and it’s not a good time to invest. On the other hand, when the “oscillator” crosses below -1 and then back above, it is a good time to invest. In the last 20+ years, three signals were triggered and they all proved correct. Right now, the Swiss Real Estate market is not cheap but the recent up-move of the interest rates, has helped to decrease the vulnerability of the market. Thus, while Monetary Policies (MP’s) on one hand can help the economy, at a closer look they are a double edge sword, so to speak. Since they can, and often do, add risk to the economic system and in turn to the investors. And this is not just confined to the Real Estate sector discussed here. Many people trying to compensate the lower returns from bonds are considering riskier investments.

Is this justified by the benefits of Quantitative Easing (QE)? Let’s look at some European data. Ideally, the QE should produce positive effects on: Inflation, Employment and Confidence. If we chart these three dimensions quarter by quarter, we should get, in theory, a picture like Figure 3.

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Figure 3

As previously mentioned, the reason is that quantitative easing should have a positive impact on all three of them. Let’s look at some real European data for these three dimensions, since the starting of the European QE:

Figure 4

As one can see comparing the pictures, what happened is not really what theory suggests. Most notably, the effect on employment tends to fade (as we

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Some of these problems also arise from the confidence given to some theories and market-extracted info. For instance, Figure 5 shows a popular measure of inflation: the 5-Year Forward Inflation Expectation Rate: the light blue line is taken in 2009 and for each month (2= Feb., 4=Apr., etc.) it shows, at that time, what the market thought inflation will be 5 years later. The orange line is where inflation actually was for each month, 5 years later, i.e. in 2014. Figure 5

Noticeably, what the market believed about inflation was wrong: the value was wrong and also the trend of the move was pointing in the wrong direction.

What if a New Recession Strikes?

Probably there is still hope and ironically it lies in an asset that central banks (CB’s) used to be very familiar with, but they seem to have forgotten about: gold. With Executive Order 6102, in 1933, right in the middle of the great depression, President Franklin D. Roosevelt launched one of the first QE operations we are aware of. With that order every US person had to sell their gold to the Federal reserve in exchange for $20.67 per troy ounce, later increased, overnight, to $35 (a 75% increase!). Let’s try to understand why. All in all, it was a very simple reason, at that time the Federal Reserve (FED) needed to back its notes with (40% of) gold and by late (19)20s the FED was very close to its limit. This prevented them from increasing the money supply. Executive Order 6102 de facto shifted that limit upwards. That same year both the real GDP and inflation got a substantial boost that lasted until the second World War. Figure 6

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How About Today?

For the last 40 years, and including the last data points, we can still see a relationship between gold and the US CPI. Figure 7

Figure 8

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Figure 9

Therefore, indications on the future direction of gold can also be used for inflation linked bonds. In Figure 9, the trading approaches that have been more suitable to generate profits on gold for the last 3 years. In green the best ones.

Wrapping up, while I think the focus should be real growth and not inflation per se, based on the actual positive results in 1933, and the data in Figure 9, I believe this makes more sense that everything we tried so far. Moreover, as it happened in the 30s it might not just boost inflation, but also the real economy.

Post Script

A better approach would be through the disposable income. This way, consumers can create (real) business opportunities for entrepreneurs which in turn will create real economic growth. But this also means less fiscal pressure on salaries and companies. Arguably a more challenging task than just buying an asset. If this is combined with a (short term) boost on energy prices (that in turn affect the prices of many things we move or produce) and wages are linked to inflation, we have a good chance of seeing a notable effect on the overall economy. Also, what some prominent economists thought about inflation and monetary policies years ago has not been confirmed by the QE.

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From the Meeting of the Federal Open Market Committee December 15-16, 2008

Bullard (President of the Federal Reserve Banks of St. Louis) [….] The way we are looking at it now, you would be talking far into the future, promising some more inflation—you know, in 2013 we will do 5 percent or something like that […]

President Evans (Alternate Member of the Federal Open Market Committee) I think that what we have contemplated will lead to the base increasing and that will generate expectations about inflation beyond just Taylor-rule dynamics, I would guess. In fact, there is certainly a lot of discussion and criticism out there that our balance sheet is going to lead to large inflationary risks.

President Stern (President, Federal Reserve Bank of Minneapolis) I do get a lot of comments and questions along the lines that President Evans mentioned – “Gee, with that expansion in your balance sheet, with all those reserves, aren’t we going to have a lot of inflation in the future?” Maybe I ought to say “yes” to that question.

President Lacker (Member of the Federal Open Market Committee) But in almost everyone’s mind is the phrase “too much money chasing too few goods.” It provides, for a lot of people, an intuitive link between money and inflation, and I think we—for all the warts of our policy in the early 1980s under Chairman Volcker—exploited that well, to convey to the public that we were committed to bringing inflation down in a simple, intuitive way. I think that can help us now, analogously, in convincing the public that we are going to be able to prevent deflation because we control money.

Author’s Notes

• Unless otherwise specified, source for all data: Bloomberg • The thoughts and opinions expressed here are those of the author alone.

Paolo F. Musto is a portfolio manager who works for one of the largest financial institutions in Italy. He also covers quantitative, statistical, technical, and financial analyses; ad-hoc and periodic forecasting reports, model development and research across major asset classes, including assessment of the impact on the markets and portfolios of economics and monetary policies. He worked for Nordea Bank in Luxembourg and for various asset management companies in the US, developing investment strategies and quantitative analysis tools. Paolo is a member of SAMT.

The Swiss Technical Analysis Journal • Spring 2017 • 43

EUR/USD

Parity Target, a Clear and Present Reality Ron William, CMT, MSTA

Why History Rhymes, but Does Not Repeat?

Despite the latest short-term weakness in the USD index, we must not forget its previous up-swing earlier on this year, which had broken out of a 2-year trading range and reactivated a historic 31-year trend breakout signal (see Fig 4).

Technically speaking, this renewed bullish USD sentiment is still part of a 5-wave cycle that started in 2011 (Fig 3). The final impulsive move offers a paradigm shift for the market’s collective investor psychology, capital flow trends and perception of key events ahead.

Source: RW Market Advisory, Market Analyst

Such a positive technical backdrop helped amplify price reactions to the Fed’s sequel 0.25% hike in Dec 2016, relative to the prior year. History had a positive market rhyme, but to a much larger extent. Back then the USD index made a higher intraday gain of 1.1%, dwarfing the previous lacklustre move of 0.02% (Fig 1).

From a macro perspective, the difference of market reaction was also driven by the Fed’s more hawkish long-term stance, which raised their “dot-plot” projection and reversed a strong 2-yr decline (Fig 2).

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Markets had become so conditioned to dovish Fed surprises, that even a mildly hawkish shift was enough to trigger significant market reactions. Speculative flows in net long USD positions also reflected greater confidence in this latest rise (Fig 2 & 3 inset).

Source: RW Market Advisory, Market Analyst

USD Breakout Signalled L-T Gains into 120

USD gains are still likely to extend sharply higher, as part of a 5-wave impulsive cycle, if and once it resumes its breakout from of a 2-year trading range (Fig 3). The move which started in 2011, represents a paradigm shift within investor psychology and capital flow trends.

Source: RW Market Advisory, Market Analyst

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CFTC large speculative net long USD positons have already triggered a bullish trend reversal and reflect growing confidence. Although these liquidity indicators do not offer precise market timing, they can still be provide valuable directional confirmation. Watch for a test of the old 2015 high to re-fuel USD.

Source: RW Market Advisory, Market Analyst

In terms of the big picture, USD’s previous upswing had also reactivated a 31-year trend breakout, which if and when triggered again, will signal further upside scope into 110 and 120. The latter price target equates to a 50% quantum retracement of the decline from 1985 and +2 STD of the USDs historical value zone (Fig 4).

A closer study of the USD’s long-term cycles (measured from peak-trough since 1985), projects an average 8-year cycle that would extend into 2019. Expect a non-linear move and stay alert for key cycle windows during midJuly, into H2 2017, when market volatility is expected to spike and renew safehaven flows into the USD and related haven assets.

Rate Divergences Pushes EUR/USD Lower

The growing divergence of interest rate policy, particularly between US and Europe, is weighing on EUR/USD. Fig 5 illustrates the spread between US/German 2-year government yields previously at a historic widening of -238bps, leading EUR/USD lower. 30-day rolling correlations remain very strong and stable at around 0.90. Here, the bond market is still likely to be acting as a potential remote proxima to currencies, where the bond-dog controls the FX market-tail e.g. by offering greater investment yield return on the USD.

On the surface level both government yields are steepening, but for very different reasons. The US curve is being led the Fed’s renewed Hawkish stance, coupled with rising l-t rising yields. Such a scenario, marked by rising short and long-end yields, with the latter outperforming, is termed as a ‘bear steepener’. Whereas, the European short-end of the curve is being pinned down by the ECB’s altered QE policy (reducing the market’s desire of holding EUR in the medium-term). In contrast, this signals a ‘bull steepener’ curve, with the short-end falling faster than rising l-t yields.

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The higher interest rate environment is also supported by a rising trend in l-t yields, pre-and-post President-elect Trump’s victory (Fig 6a). This marks an important end of the 35-year bear trend in yields, after a two-stage bottom process in 2012 and 2016. Potential remains for a UST yield rise to 3%, which equates to +1 STD of the historical mean (Fig 6b).

Source: RW Market Advisory, Bloomberg

Source: RW Market Advisory, Market Analyst

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This psychological level could indicate a pain threshold for rising inflation, weighed by toxic debt or/and future tail-risk (see Fig 8b).

Parity Target, a Clear and Present Reality

EUR/USD is currently trading at a make or break level at 1.0970-1.1015. If the major rate fails here, it will suggest a resumption back down to its extreme low at 1.0341, which serves as the lowest level since 2003. The move would be part of a much larger historical price symmetry last seen between 19852001, which exhibited a two-stage impulsive rise and volatile corrective fall. Both price analogs developed strong uptrends, lasting 91-93 months that were short-circuited by crisis events. (Fig 7).

Source: RW Market Advisory

A sustained weekly close beneath 1.0341 would make the parity target a clear and present reality, into a 31-year trend support. Of note, EUR/USD parity target was projected over 2-years ago, following a major breakdown from a 12-year accumulation pattern, supported by a long-term bear cycle skew (Fig 7 inset). Using more traditional methods such as Point & Figure charting also signals further downside scope into 0.9900 and 0.9700 (Fig 8a). The latter target was activated in October 2014. Only a close back above 1.1000 (value zone) would neutralize this scenario.

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There is a perfect storm of asymmetric risk, marked by the latest technical breakdown, growing interest rate divergences, compounded by geometric event risk into 2017 (Fig 8b). The highest probability tail risk is signalled by our timing models, predicting a panic/rogue cycle this year. Political instability in the Euroland is a plausible trigger, not least, ahead of the oncoming elections. Both factors are EUR/USD negative.

Source: RW Market Advisory, Jeremy duPlessis, Updata, Bloomberg

Ron William, CMT, MSTA, is a market strategist, educator and trader, with 17 years of financial industry experience, working for leading economic research and institutional firms; producing macro research and trading strategies. He specializes in macro, semi-discretionary analysis, driven by cycles and proprietary timing models. Ron is a board member of the International Federation of Technical Analysts (IFTA),Vice President & Head of the Geneva Chapter of the Swiss Association of Market Technicians (SAMT) and Honorary member of the Egyptian Society of Technical Analysts (ESTA); holding both the MSTA and CMT professional designations. He is also cofounder of the SAMT CFTe Immersion Course and SAMT Journal.

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The Swiss Association of Market Technicians (SAMT) is a not-for-profit organization that does not hold a Swiss Financial Services License. It is the aim of the SAMT to promote the theory and practice of technical analysis, and to assist members in becoming more knowledgeable and competent technical analysts, through meetings and encouraging the interchange of materials, ideas and information. In furthering its aims the SAMT offers general material and information through its website and publications therein. The information provided on the SAMT website has been compiled for your convenience and made available for general personal use only. SAMT makes no warranties implied or expressly, as to the accuracy or completeness of any information contained on the SAMT web site. The SAMT directors, affiliates, officers, employees, agents, contractors, successors and assigns, will not accept any liability for any loss, damage or other injury resulting from its use. SAMT does not accept any liability for any investment decisions made on the basis of this information, nor any errors or omissions on the SAMT website. This web site does not constitute financial advice and should not be taken as such. SAMT urges you to obtain professional advice before proceeding with any investment. The material may include views and statements of third parties, which do not necessarily reflect the views of the SAMT. Information on this website is maintained by the people and organization to which it relates. The SAMT believes that the material contained on this website is based on the information from sources that are considered reliable. Although all care has been taken to ensure the material contained on this website is based on sources considered reliable we take no responsibility for the relevance and accuracy of this information. Before relying or acting on the material, users should independently verify its accuracy, currency, completeness and relevance for their purposes. Before making any financial decision it is recommended that you seek appropriate professional advice. The SAMT website may contain links to other websites, these are inserted merely as a convenience and the presence of these links does not constitute an endorsement of the material at those sites, or any associated organizations, products or services.

The Swiss Association of Market Technicians Established 1987

SAMT encourages the development of technical analysis and the education of the financial community in the uses and applications of the technical research and its value in the formulation of investment and trading decisions.

www.samt-org.ch

Benefits of Membership

• The organisation of meetings on a broad range of technical subjects encouraging the exchange of information and knowledge of technical analysis for the purpose of adding to the knowledge of the members.

• These meetings provide an excellent opportunity to meet and socialise with other traders in your local area and thus develop friendly and professional relations among financial market specialists. • The organisation of presentations from guest speakers from around the world.

• SAMT is affiliated with the International Federation of Technical Analysts (IFTA). All SAMT members are, therefore, colleagues of IFTA and are entitled to attend the annual IFTA conference at reduced rates. • The “IFTA Update” - the quarterly newsletter from the International Federation of Technical Analysts.

• The possibility to sit for the Certified Financial Technicians (CFTe) at a discounted rate. These exams are controlled by IFTA.

• Members receive discounts on a range of products and services related to technical analysis, including software, tuition, seminars and reference books. • Only fully paid-up members have access to the member area and SAMT events.

Cost of Membership

• Initial one time registration fee of CHF 50.

• The membership cost for each subsequent year is CHF 150. (The total cost for the first year is CHF 200).

Membership Payments to Join or Renew

To renew your membership or to join online, log onto our website.

The Swiss Technical Analysis Journal • Spring 2017 • 53

IFTA CERTIFIED FINANCIAL TECHNICIAN (CFTe) PROGRAM

Examinations

regularly takes place in major cities throughout the world. Additional fees apply to candidates requesting the exam in a non-English language or non-IFTA proctored exam location. IFTA will attempt to accommodate any exam location request. In preparation for the exam, candidates should use this Syllabus and Study Guide (CFTe II). Register here for the next CFTe II on 19 October 2017. The deadline to register for this exam is 1 September 2017. No registrations will be accepted after this date. No registrations will be accepted after this date. Download practice (mock) CFTe II examination.

Curriculum

Passing the CFTe I and CFTe II culminates in the award of an international professional qualification in technical analysis. The exams are intended to test not only your technical skills knowledge, but your understanding of ethics and the market. Level I: This multiple-choice exam consists of 120 questions covering a wide range of technical knowledge, but usually not involving actual experience. In preparation for the exam, candidates should use this Syllabus and Study Guide (CFTe I). This exam is currently offered in English, German, Spanish and Arabic. It will be offered in Chinese at a later date. Download the CFTe I practice (mock) examination (English) or CFTe I practice (mock) examination (Arabic). Level II: This exam incorporates a number of questions requiring an essay based analysis and answers. For this, the candidate should demonstrate a depth of knowledge and experience in applying various methods of technical analysis. The exam provides a number of current charts covering one specific market (often an equity) to be analysed, as though for a Fund Manager. The CFTe II is a paper and pencil exam that is offered in English, French, Italian, German, Spanish, and Arabic, bi-annually, typically in April and October. It will be offered in Chinese at a later date. This exam

The program is designed for selfstudy. Local societies may offer preparation courses to assist potential candidates. n

Exemptions

Individuals who have successfully completed IFTA accredited certification programs through: Australian Technical Analysts Association (ATAA), Egyptian Society of Technical Analysts (ESTA), Nippon Technical Analysts Association (NTAA), and Society of Technical Analysts (STA) are exempt and may proceed directly to the MFTA program. See below for more details: Individuals who have successfully been awarded the Diploma in Technical Analysis (DipTA) by the Australian Technical Analysts Association (ATAA) are considered to have the equivalent of the certificate and may apply for the MFTA Program.

Individuals who have successfully completed Levels I, II, & III of the Certified ESTA Technical Analyst Program (CETA) through the Egyptian Society of Technical Analysts (ESTA), and have been awarded the CETA diploma, are exempt from both levels and may proceed to the MFTA Program. Individuals who have passed Level I and Level II of the certification program offered by the Nippon Technical Analysts Association

(NTAA) and have been awarded the designation of Chartered Member of the Nippon Technical Analysts Association (CMTA) are also exempt from both levels and may proceed to the MFTA Program.

n Beginning

January 2013, individuals who have passed the STA Foundation and Diploma Courses offered by the Society of Technical Analysts (STA) and have been awarded the designation of Member of the Society of Technical Analysts (MSTA) are eligible to receive the CFTe certification (please contact STA’s Administration for procedures) and may proceed with IFTA’s MFTA Program. Prior to January 2013, holders of the Society of Technical Analysts (STA) Diploma are exempt from Level II, but must pass Level I (a multiple-choice test) before qualifying for the CFTe certification.

Additionally, n Individuals who passed the Market Technicians Association (MTA) Chartered Market Technician (CMT) levels I and II on, or before, 28 June 2013, are eligible to receive the CFTe certification. Please submit an application and provide a pass confirmation from the MTA, including dates attained. There is a one-time application fee of $550 US. No future fees or membership requirements apply.

Cost

IFTA Member Colleagues

CFTe I CFTe II CFTe I CFTe II

$550 US $850* US

Non-Members

$850 US $1,150* US

*Additional Fees (CFTe II only): n $100US applies for non-IFTA proctored exam locations For more information on the program please email admin@ifta.org

54 • Spring 2017 • The Swiss Technical Analysis Journal

Swiss CFA Society

SAMT PARTNER SOCIETIES

Groupement Suisse des Conseils en Gestion Independats (GSCGI)

CSCGI is a group of economic interests formed by specialized independent financial intermediaries who are confirmed professionals in the financial services industry. The group is open to contacts with any person interested in the business of wealth management seeking to promote dialogue with the banking partners and authorities at all levels. Their goals are to: n Promote contacts between professionals motivated by the same desire for independence, wishing to maintain and develop relationships with counterparts. n Find common ground for exchanging experiences and ideas, a field where diversity and novelty are prevailing. n The enrichment of the links that can be forged on a friendly and professional level within a well defined and recognized framework to favour professional consultation and close dialogues. www.gscgi.ch

Journal Media Sponsor

The Swiss CFA Society boasts over 2,400 members in Switzerland, against barely 100 in 1996 at inception. It is the largest CFA Institute society in continental Europe. With more than 2,000 candidates taking the rigorous Chartered Financial Analyst® (CFA®) exam in Switzerland each year, the society’s impact on the Swiss investment community is selfevident. It was the first society of CFA charterholders in the EMEA region to be directly affiliated with the prestigious CFA Institute, which includes more than 110,000 members in 139 countries. The vision of the Swiss CFA Society is to be a leader in fostering the highest level of knowledge, professionalism, and integrity in the investment business. www.cfasociety.org/switzerland

Swiss Futures and Options Association

The Swiss Futures and Options Association (SFOA), previously the Swiss Commodities, Futures and Options Association, was founded in 1979 as a non-profit professional association for the purpose of promoting derivative financial instruments, particularly standard futures and options contracts on financial instruments and commodities, to the widest possible audience, and to serve the interests of its members. SFOA serves users of commodity and financial derivatives, as well as professionals, their institutions and the exchanges. www.sfoa.org

International Federation of Technical Analysts (IFTA)

IFTA is a non-profit federation of 26 individual country societies who individually and jointly dedicate themselves to

Research, education, camaraderie and dissemination of technical analysis of world markets. The IFTA societies support sharing technical analytical methodology that at its highest level is a valid, and often-indispensable element in the formulation of a reasonable basis for investment decisions. n Promotion of the highest standards of professional conduct, international cooperation and scholarship between all its Member and Developing Societies within all arenas of technical analysis. n Providing centralized international exchange for information and data of various financial centers while respecting individual country and Society business practices, legal structures and customs. n Encouraging the standardization of education and testing of its constituent members in technical analysis, making sure that each individual country’s security analyst licensing, legal and language /communication priorities continue to be individually accepted. n Fostering the establishment of individual societies of technical analysts without bias in regard to race, creed or religion. It supports the need for maintaining a free and open worldwide markets under normal, and in particular crisis periods. As a growing bridge of communication worldwide, IFTA remains open to methods of technical analysis, while encouraging the consideration and support of membership for both developing and established societies. n

www.ifta.org

Training: www.technicalanalyst.co.uk/courses/calendar/ Awards: www.technicalanalyst.co.uk/awards/the-technical-analyst-awards-2016/ Research: www.technicalanalyst.co.uk/research/ The Swiss Technical Analysis Journal • Spring 2017 • 55

The village of Silvaplana 56 • Spring 2017 • The Swiss Technical Analysis Journal

Photo: Alberto Vivanti

The Swiss Association of Market Technicians ZÜRICH • GENEVA • •LUGANO The Swiss Technical Analysis Journal Spring 2017 • • 57CHUR