By Chris Ebert

If emotions are reflected by the stock market then it stands to reason that those same emotions might be reflected in popular music. The same patterns that are perceived as pleasurable to the ear might be expected to be pleasurable to a trader’s sense of market timing, just as  dissonant musical tones might be equivalent to indecisiveness among traders.

Some years ago a group of musicians known as the “Axis of Awesome” noted that most popular songs in the past 40 years have followed a single chord progression known as the I V vi IV progression (also known as the C G Am F progression). In their words, “All the greatest pop songs ever written just use four chords, it’s the same four chords for every song.”

In much the same way, the stock market has grown to like just four chords much of the time, particularly during a Bull market. Those four chords correlate to four distinct trading environments: Stage 1, Stage 2, Stage 3 and Stage 4. Much of the time, the S&P 500 lies within one of those four environments, much like the S&P is playing a song for us all.

  • Stage 1 is known here as the Lottery Fever stage, a euphoric environment where good news is great and bad news is often ignored. That’s the “I” chord, upbeat and carefree.
  • Stage 2 is the Digesting Gains stage, where good news sends stocks higher and bad news gives profit-takers an excuse to cash in and take their gains. That’s the “V” chord, upbeat, but with a little tension.
  • Stage 3 is the Resistance stage in which there is a sense of tension and folks aren’t willing to push stock prices higher but are not willing to throw in the towel either. That’s the “vi” chord, lots of tension.
  • and finally Stage 4, the Correction stage in which stock prices pull back to more natural levels based upon their earnings. That’s the “IV” chord, release of tension.

The process then repeats, almost as if it were following a top-40 pop hit on the radio, that is… until the song ends.

 

OMS 07-24-16a1

In popular culture, music mimics the stock market. Stocks go through those four stages in a manner that is quite similar to the four chords that are present in most popular music. Of course, as traders, we can never be sure exactly what song is playing in the stock market at the current moment, or what time the song will end. But as long as there is a pattern we can glean some insight into the market by recognizing that pattern.

The current pattern puts the S&P 500 in Stage 2, the “V” chord. With earnings coming out in full force this next week, some tension is to be expected. It’s all part of a natural process – as natural as music to the ear. Whether the market reverts back to the carefree “I” chord, Lottery Fever, or whether it progresses to even more tension in the “vi” chord, Resistance, is anyone’s guess. But either way, it’s like music to the ear.

Options Market Stages

Click on chart to enlarge

Obviously the stock market isn’t going to follow the rules for a Four Chord Song all the time, just as the songs on the radio don’t always comply with that rule. There will be times when different rules apply, as illustrated in the following jingle from the 1970s that doesn’t follow the I VI v IV progression, but instead goes by I V I IV V64. Even so, one can feel a different mood with each chord, just as there is a different feel to the market with each different Options Market Stage. The progression of the stages isn’t always clear, but the mood in each stage is quite similar to the mood of each chord in a musical progression.

Ba ba… (I)
Ta ta….(V)
Dum dum da dum…(I)
Da da um bump phah!…(IV)
Da da da dot tah! (V64)

The reason it is important to note the difference is that it’s never a good idea to predict the future, whether it be through the Options Market Stages or through musical chord progressions. There’s always a chance the song won’t follow the rules!

The best a trader can hope for is to make an educated guess on what the next chord in the progression is likely to be. But like the difference between Pop Hits and TV jingles, there’s never a guarantee. We make our best prediction based on the “rules”, but we are always cautious with our portfolios because we know those rules will be broken at times.

The preceding is a post by Christopher Ebert, Chief Options Strategist at Astrology Traders (which offers subscribers unique stock-trading perspectives and options education) and co-author of the popular option trading book “Show Me Your Options!” Chris uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. Questions about constructing a specific option trade, or option trading in general, may be entered in the comment section below, or emailed to OptionScientist@zentrader.ca

 

Related Options Posts:

Orange Line of Violence Often Influences Stocks

Thursday Evening Options Brief 18-Feb-2016

Historical Bear-Market Option Performance

Leave a Reply

You must be logged in to post a comment.