Technical analysis

They’re young, smart, mobile and sat across from me after back-packing half-way across the western world. After all, school starts soon, and teachers are expected to shave and show up.

Soon our chat turned to real estate – which every young couple seems obsessed with. “We understand the risk,” they said, “but it’s the peer pressure that’s killing us. After all, you gotta remember that everybody our age thinks houses always go up.”

And then they reminded me. The last time real estate took a dump, they were in grade 7.

So, we began the lesson.

The first phase of this housing correction was more like a nudge than a slap. Over the summer the number of buyers melted away, sales levels dropped and excuses flowed.

Real estate professionals blamed rising mortgage rates, then tougher lending regs, the weather and finally the HST. The problem, of course, was that we’d reached a point of unaffordability and many were starting to see danger.

The second phase is happening now. This is the slap.

After three months of lousy sales numbers and wobbling prices, the risk in buying a house has just been underscored by the media. Suddenly, it’s in everyone’s face. A couple of pseudo-academic reports in the last few days have given reporters the third-party source they were looking for. Suddenly the bubble talk that frothed around here is on the front page, the six o’clock news and magazine covers.

And so the door opens for the third phase. This is all about behavioural economics. And it’s the same stuff that stock market chartists use in their technical analysis. It means one simple fact – that human emotions, not economic fundamentals, will now set the rules of this game.

As I wrote in my current book, Money Road, technical analysis measures how much fear or greed’s in the air. This is done in part by studying price changes, trading volumes and the amount of time it takes for patterns and trends to appear. Based on that, there are three assumptions made:

  • History repeats.
  • Trends persist, and
  • markets move based on known facts. In other words, there’s no point worrying about information that can’t be known, since market action itself tells you all you need to know.

There’s another crucial assumption: one thing never changes about markets – people always think the same way. This yields a few more conclusions. When a trend shows up in a market, it’s there for a reason, and will probably persist. So, until it reaches an extreme point, smart investors should just follow until technical analysis clearly shows that extreme moment has been achieved (like Vancouver house prices right now). The extremes always have one of two things in common, which is fear or greed. For example, stock markets reached maximum despair and capitulation in the winter of 2009 when the media was full of stories about a new depression and a collapse of the financial system. Conversely, they were euphoric and greed-bound in 1929 (just prior to the sell-off that October) and in 1999 (when dot-com mania swept us into uncharted territory).

Technical analysis says investors should not argue with an asset price or try to hedge against future movements, because it’s doing so for a reason. If more people want to buy than sell, the thing will rise and keep on rising, until investor psychology changes. And when it does, that will show up on the analysts’ charts, in their moving averages and in real estate board sales numbers in Calgary and Toronto. The key to winning, then, is to anticipate the herd.

How do you know when a bull trend is about to turn into a bear? When your profits will morph uncontrollably into losses? Why don’t more people see this?

Technical analysis says there are always levels of resistance, above which buyers won’t enter the market because they think an asset costs too much, and levels of support where investors think something is so cheap they must buy. By plotting prices and volumes, they seek to identify these points and therefore trace investor sentiment. If an asset price breaks out of an identified trend – and smashes above or below one of these markers, then that signals a new phase which can be either bullish or bearish. In other words, that’s the moment a buy or sell decision should be made. Despite the assurances of the market pros, investor greed had been shattered. It was all over. Zip. Get out.

For Canadian residential real estate markets, that moment is now.

In the coming weeks and months you will be hearing more about declining sales volumes, and then lower prices. As housing values fall, it will make no sense for buyers to grab a falling knife. After all, the price an anxious seller wants in October will likely be higher than the one a desperate vendor will accept in March.

And as more and more people understand real estate can fall as easily (and more swiftly) than it rises, then the fewer who will want to stand under it.

Out of this will come a moment of capitulation, when prices become so irresistibly cheap that fear reverts to greed. Panic becomes lust. The herd spins on a hoof, and thunders back up the chart.

That moment will surely come. But our American friends have been waiting five years since they experienced the moment we now taste. It’s estimated it will be 17 years before peak 2005 prices are seen again.

Teach your children.