Anyone who has seen the classic holiday cartoon “A Charlie Brown Christmas” is familiar with the scene when Linus takes the podium, says “Lights please”, and proceeds to tell the nativity story from the Gospel of Luke. Fewer of you are likely familiar with another story of a historic figure, this one actually born on December 25, reportedly. (I wasn’t there. I can’t verify this as a certainty.) See if this sounds familiar:

“Medieval, in some disrepair, the Woolsthorpe farmhouse nestled into a hill near the River Witham. With its short front door and shuttered windows, its working kitchen, and its bare floors of ash and linden laid on reeds, it had belonged to Newton’s forebears for just twenty years. In back stood apple trees. Sheep grazed for acres around. Isaac was born at the top of the stairs. By the terms of feudal law this house was a manor and the fatherless boy was its lord, with seigniorial authority over a handful of tenant farmers in nearby cottages.[i]”

It’s all there; Instead of a manger in a stable it was a farmhouse in “some disrepair”, rather than a star in the east there were apple trees in the back (a key part of the gravity story yet to come), in both stories sheep grazed nearby while the fatherless boy, a lord, slept. All that’s missing is the mysterious appearance of Three Wise Men in the second story, though these would come later as some of the greatest minds the world has ever known would pay homage to the boy born on Christmas Day 1642.

Those of you who have followed me through the years know I consider Sir Isaac Newton the Father of Technical Analysis, though I doubt this ever occurred to him as he was putting together his thoughts on the nature of everything and Laws of Motion. While it could be argued all these can be applied to market analysis (gravity, motion, etc.), it’s the latter I tend to talk about. If we apply Newton’s First Law of Motion to analysis we get: A trending market will stay in that trend until acted upon by an outside force. You can also see this in the John J. Murphy book “Technical Analysis of the Futures Markets”, 1986 edition. To quote (page 3), “There is a corollary to the premise that prices move in trends – a trend in motion is more likely to continue than to reverse.”

This makes my job, and others who actually pay attention to markets, quite simple. Watch the trend of a market. What is a trend? Throw out all the talk of retracements (Dow, Fibonacci), waves (Elliott), and all of the “indicators” and we are left with the simple definition of “price direction over time”. That’s it. As I talked about recently, I’ve generally lost my interest in the larger field of technical analysis (Losing My Religion, December 1) due to the evolution of the investment industry toward algorithm-driven trade. The reality is most trading programs don’t use traditional technical analysis, but instead are heavily influenced by volatility and moving averages. Since each algorithm can be written to use any set of factors, it is impossible to project how it might react at any given time. Therefore, all we have to do is watch the direction of prices and wait for a change. We can simplify this further if we apply the Wilhelmi Element (named for the late Gary Wilhelmi, a friend and longtime Chicago Board of Trade reporter), “The only price that matters is the close.”

In my application of Newton’s First Law of Motion, what is meant by “acted upon by an outside force”? In the commodity complex, markets have two sides: Commercial and Noncommercial. The commercial side is made up of merchandisers, brokers, traders involved with the underlying cash commodity. In Grains, this would be exporters, importers, crushers, mills, etc. The noncommercial side consists of global investment funds, generally dominated by trading algorithms, a group I’ve long called Watson. (Not for Sherlock Holmes’ assistant, but rather the IBM computer program.) A market’s trend can change direction when one, or both, of these sides changes its mind. As Newsom’s Market Rule #5 says, “It’s the what, not the why.” In other words, we might not know why one side or the other changes its mind, but we can see what group is changing. Then there’s Rule #6, “Fundamentals win in the end”, that tends to explain things.

Back in the day, when the Newsom family would get together for the holiday, it would include all of us standing around Grandma playing the piano while we sang Christmas carols. Looking back, I wish I would’ve at least once suggested singing “Way Up High in the Apple Tree” for Sir Isaac.

Until next time.

Darin Newsom

[i] From the book “Isaac Newton” by James Gleick, page 9