Lines clue to market moves

As investors will be aware, we have had a nice run up in Australian shares since the last Greek-induced funk in June. The All Ordinaries Index is up 27 per cent since then and 17.4 per cent since another dip in late November. For the calendar year the climb is 9.5 per cent.

The half-yearly profit reporting season just completed gave investors cause for optimism, with the more gloomy predictions of some analysts not coming to pass. But "where to from here?" The market is still 1000 points below its pre-crash highs, but three of the major banks, Commonwealth, ANZ and Westpac are either at new all-time highs or close to it.

Capital gains are, of course, what investing is all about, but the past five years have taught investors that capital protection is a vital tool to holding on to your gains and getting a good night's sleep. This week Robert Brain, a director with the Australian Technical Analysts Association, demonstrates a tool that can help us keep a dose of reality in our decision-making.

Mr Brain has drawn a chart of the all Ordinaries Index dating back to September 2010 and under this a chart of the 28-week All Ordinaries Momentum Index. Each point along this curve indicates the amount of change in the index over the previous 28 weeks. "In normal conditions, the Momentum indicator and the index will rise ... and fall together. When the index makes new highs, the Momentum will normally make new highs also," he says.

Watching these two charts will alert analysts to "divergence". In this case the divergence we are looking for is where the market index continues to rise but the momentum index begins to fall, indicating the strength of a market rise is weakening.

Look at the charts and you will see how at points 1 and 2 the index and the momentum indicator were both rising, indicating a strong market. But well before the market peaked in early 2011, the momentum indicator began to fall at the line market 3. That presaged a 21 per cent fall on the market.

Early last year the same phenomenon occurred with lines 4 and 5 indicating a rising market. However, the momentum indicator turned down once again at line 6 while the All Ords was still rising. The end result was an 8 per cent market tumble.

Now, Brain observes, we may be seeing divergence again with the very latest point on the momentum index a little lower than its previous trough in late January. The divergence will be confirmed if the momentum index can't make a higher point in coming weeks.

W. D. Gann was an early 20th-century trader who used arcane theories of natural laws he saw in mathematics and what he called "vibration" to predict market moves. His followers say this method yielded him an 85 per cent success rate on market trades. Gann's theory apparently predicts a change in market direction in March, usually between the sixth and the equinox on March 22.

This column is not investment advice. rodmyr@gmail.com