#-ad_banner-#As some of you may know, I use technical analysis extensively, incorporating it into my trading strategy along with fundamental and quantitative analysis. 

In simple terms, technical analysis requires a study of the past, as market patterns tend to repeat over time. Beyond that, though, technical analysis can vary; some analysts use charts, some use indicators and computer testing, and some rely on history books. I think all three techniques are important to consider. 

Chart patterns do tend to repeat over time. While it is possible to take this idea too far (which many people do), we can often spot broad patterns on charts that help us identify major trends. For example, the chart below highlights bullish double-bottom patterns (blue boxes) that developed in the S&P 500 over the past year.

But it’s also important to remember that no pattern will ever work 100% of the time, as this chart illustrates. In the red box, you’ll see a double-bottom pattern that didn’t work. 

And that’s where indicators and computer testing come in: They quantify how effective different indicators actually are. 

There are hundreds, if not thousands, of technical indicators. I have tested many of them and found almost all of them fail to work as advertised. One such test was the basis of a paper I wrote last year called “Fixing the VIX,” which was recognized by the Market Technicians Association with the 2015 Charles H. Dow Award. 

In the paper, I found an indicator that was profitable even though it identified winning trades only about 45% of the time. More importantly, I explained a way to use that indicator to time options trades with a win rate of more than 90%. (This indicator is one of the pillars of the strategy I use in my premium newsletter, Income Trader, where my subscribers and I booked 128 winning trades in a row.) 

Now, charts and indicators are both based on reading current market action — analysis that can (and should) be supplemented with history books. I was reminded of this while reading about the European Central Bank’s (ECB) plan to start buying corporate debt under their quantitative easing (QE) program. The ECB has done so much of this easing that they are running out of government debt to buy — a situation that felt familiar to me. 

I then remembered this very situation was the focus of an entire chapter of the 1841 classic, “Extraordinary Popular Delusions and the Madness of Crowds.” As you can probably tell from the title of the book, it didn’t work very well. In the book, Charles Mackay describes historical cases of mass hysteria — things like the Salem witch trials and the Mississippi Bubble in French stocks that occurred around 1720. 

In the latter example, France ran up excessive debt in the early 1700s by funding explorations to the New World while fighting expensive wars in the Old World and maintaining a king who spent extravagantly. Rather than paying down the debt or cutting spending, King Louis XV teamed up with economist John Law to convert the debt to stock in a company that would find great wealth in its exploration of North America. The scheme worked for a while (almost four years), but eventually the bubble burst, and France’s economy suffered for many years. 

Despite this failure, the idea of making debt disappear is still attractive to governments nearly 400 years later. Yet by studying history, I know that even if this idea works for a few years, it’s possible we’ll see a bubble in stocks before it’s all over. In fact, I believe we might be in the early stages of a bubble now, which is the time when quick gains from stocks are possible. Based on history, I have some indicators that have worked well in previous bubbles, and they should help us generate profits in the future. 

If, like me, you’re concerned about a possible bubble in the stock market, then I urge you not to panic. As I said before, I believe there is still ample opportunity for investors to profit before time runs out. But you’ll need to get in and out of trades quickly — and have mechanisms in place to limit your losses before things get out of hand. If you’re curious about how my Income Trader readers and I are able to do this — as well as collect thousands of dollars every month — then you should check out my special presentation here.