TRADING & Investing

A MACROWAVE PLAY, in three acts

Any trader can follow the twists and turns of a price
chart. However, truly knowledgeable traders
understand why the market moves the way it does.
A close look at a stock over a 10-month period shows
how “macrowave” factors are reflected in price action.

From October through November, the
chip sector was in a steady upward
trend, filling the gap down that occurred
on the chart in September 2001.
However, in December 2001, the market
ran into substantial choppiness and
began to form a rounding top pattern,
which eventually found support at the
high and low of the September gap. As
the top formation unfolded, on-balance
volume (OBV) and the moving aver-
BY PETER NAVARRO age convergence-divergence indicator
(MACD) trended downward, signaling a
decline in prices was forthcoming. The
MACD eventually crossed below the
have amassed a healthy gain across his
long and short positions — perhaps as
much as 120 percent.
If only technical analysis and trading
were so easy! In fact, particularly during
the intervals in which the market was
either trading sideways or moving
down, there was substantial volatility
and enough false signals to lure our
technician-cum-position trader into a
variety of traps — unless, of course, the
trader was keenly aware of the broader
macroeconomic forces driving the sector.
With such macrowave awareness, here’s
how our trader might have viewed the

A
true understanding of the
underlying macr oeconomic
events or “macrowaves”
that move the markets will
significantly improve your performance
as a chart-oriented trader. To explore that
theme, a chart of the semiconductor sec-
tor stock (SMH), which tracks the move-
ment of the semiconductor sector, will be
analyzed in light of the macro events that
occurred over a particular time period.
Consider a typical position trader
who sought to speculate in SMH from
October 2001 to August 2002. Figure 1
(opposite page) shows the unfolding of a
simple three-act play.
zero line in late April 2002. Prices
gapped down and broke support in June
2002, triggering a short position in SMH.
(If you’re unfamiliar with the MACD or
OBV indicators, see the Web Extra for this
article at www.activetradermag.com.)
In evaluating these price movements,
our hypothetical trader might have
bought SMH sometime in October and
sold it in November or early December.
Assuming he would have left the day-
and swing-trading plays on SMH to oth-
ers, he might have remained completely
out of the sector through March. At some
point — most likely in May or June —
his technical indicators would have sig-
naled an SMH short sale, which proba-
bly would have been covered in August.
By the time the play was over, he would
unfolding price action and avoided mis-
steps.
Act I
We’ll start with SMH’s initial upward
trend. The stock market was trying to
make the successful move from a late-
bear to early-bull phase of its cycle.
During this time, the economy remained
in the painfully slow process of making
the change from recession to expansion.
It was strongly aided by the Federal
Reserve, which had dramatically cut
interest rates and increased liquidity in
the wake of the Sept. 11 terrorist attacks.
In addition, the prospect of a significant
increase in expenditures for the war on
terrorism promised a nice fiscal stimu-
lus, and Wall Street seemed convinced of

92 www.activetradermag.com • November 2002 • ACTIVE TRADER

a nice “V-shaped” recovery that would nasty oil price shock. Within weeks, India accuracy of accounting statements draws
shower corporate America with higher and Pakistan amassed troops on their a larger band of uncertainty around those
profits and bolster stock prices. borders amid legitimate concerns of earnings forecasts, investors will necessar-
During this attempted late-bear to nuclear war. ily discount this increased risk by selling
early-bull transition, several key sectors In January 2002, “Enronitis” — concern off stocks.
led the way. In the “old econo-
my,” it was both autos and hous- FIGURE 1 THE TECHNICAL SIDE
ing, as consumers unleashed This chart of the semiconductor index stock (SMH) shows the technical side of price
pent-up demand in reaction to action, but without the knowledge of the macroeconomic developments driving the
lower interest rates and the market, a trader’s understanding is incomplete.
prospects of recovery. On the
Semiconductor Sector Stock (SMH), daily “Rounding Top”
tech side, it was typically semi- Daily formation is bearish.
conductors that came roaring “Gap” down in
back in anticipation of heavier June 2002 50.00
chip demand for the toys, com- confirms top
puters and other doo-dads con- and sell point. 45.00
sumers covet, as well as the
Top and bottom of “gap” 40.00
sophisticated equipment funded
left on September 2001
by renewed business invest- 35.00
serves as support.
ment. It was precisely this expec-
tation of a robust recovery that 30.00
began to drive SMH upward.
25.00
Note, however, that on the
supply side, there was a very Apr. May June July Aug. Sept.Oct. Nov. Dec. 2002 Feb. Mar. Apr. May June July Aug.
interesting macrowave unfold-
On-Balance Volume
ing as well. First, most (if not all)
of the chipmakers were gearing
up production in anticipation of
the next boom. More subtly, in
this particular cycle, the most
OBV and MACD begin trending down and diverging
innovative of the companies from price. MACD crosses and remains below the zero
were moving to new “jumbo line. These signal a top and a pending price decline.
wafer” technology that allowed
them to increase chip production MACD
with a 30-percent cost reduction.
Together, these two macrowaves
would add up to a possible chip
glut if the recovery failed to fol-
low through, or if it were merely
modest instead of robust.
Source: David W. Aloyan

Act II
Now let’s look at the second trading
range interval in the figure. Beginning in
December 2001, the economy and mar-
kets began to suffer from a veritable
macrowave storm. After repeated suicide
bombings, the Israeli Prime Minister
declared war on terrorism and sent
troops and tanks into the West Bank. This
helped trigger what soon became a very
over accounting fraud — started to spread
to other major companies such as Tyco,
PNF Financial and Williams. Over the
next eight months, this scandal would
morph into a full-blown crisis in corporate
confidence, and the bearish problem was
clear: Over the longer term, stock prices
are based on expectations about future
earnings streams. If uncertainty about the
However, there was also good news in
this market. On the macroeconomic data
front, consumer confidence remained
strong, productivity continued at rip-roar-
ing levels, inflation was low and the
unemployment rate was beginning to fall.
On the supply side of the economy, the
critical ISM index was gathering strength.
continued on p. 94

ACTIVE TRADER • November 2002 • www.activetradermag.com 93

Act III
Regardless, by March, concerns over the
contractionary effects of the latest oil
price shock finally trumped a nascent
recovery. As the price of oil spiked to a
six-month high on speculation the U.S.
might invade Iraq, both SMH and the
broader market rolled over and began a
clear downtrend. In this regard, investors
94
know that just as chips are the first tech
sector to celebrate recovery, they are also
the first to be hit by recession.
Moreover, even though it was not yet
clear the economic recovery was signifi-
cantly faltering, the aforementioned col-
lective actions of the chip sector, in terms
of both over-production and the jumbo
wafer macrowave, were beginning to do
www.activetradermag.com • November 2002 • ACTIVE TRADER
the sector in. With DRAM prices soft, the
smart money now firmly believed a
merely modest economic recovery
wouldn’t be enough to lift the chip sec-
tor, which could soon bloody itself with
destructive competition.
As if all this weren’t bad enough, in
April, as SMH and the broader market
continued to slide, a significant buzz
developed over the weakening dollar.
The problem here was that as the dollar
weakened, foreign investors tended to
pull money out of the U.S. market to pre-
vent any loss from currency devaluation.
However, the withdrawal of foreign cap-
ital further eroded the market, triggered
more foreign disinvestments, and per-
petuated the vicious downward market
spiral that continued to gather steam
through June.
In the false dawn of June, there
seemed to be light at the end of the reces-
sionary tunnel. The macroeconomic data
was now mixed, but each new report
could have been interpreted in such a
way that suggested the economic recov-
ery was proceeding — particularly when
the Fed Chairman kept telling us this
was the case. Indeed, at this point, we
saw a brief stabilization of the market
and a short rally on the renewed
prospects of a successful transition from
late bear to early bull.
But hopes of a solid recovery were
once again thrown into question by the
end of August by weak macroeconomic
fundamentals and yet another oil price
spike. This caused our savvy position
trader to move into September — histor-
ically the market’s cruelest month —
with much macrowave trepidation.
Big picture
The broad message of this story is that
one technical chart is indeed worth a
thousand macrowave words. But by
understanding the macroeconomic story
behind the technical patterns, you will
be better able to anticipate price move-
ment in the markets and become a better
trader.Ý
For information on the author see p. 10.
The chart and accompanying technical
analysis in this article were provided by
David W. Aloyan, with whom Navarro pub -
lishes “The Savvy Macrowave Trader.” The
free weekly newsletter can be accessed at
www.peternavarro.com.