If your work isn’t working…here’s a solution
I doubt many traders would disagree with me when I say “This is tough!” In fact this is about as bad as I have ever seen it for short term trading and understandably many traders are feeling disillusioned. There is every reason to feel disillusioned, it is our job to trade but the markets are not conducive to providing payment for our efforts.
But there are two reasons to keep our spirits up as much as possible:
- There is a simple formula for working through such times, and
- Better times are on the way
My survival formula
Those who trade with me in my Trading Den each week already know this formula for surviving times as rough as this. This is why we have been able to hold onto our equity highs throughout this taxing last few weeks.
But for those that don’t know my survival formula, here it is. The plan has three elements to it:
- Trade much less frequently
- Risk far less on each trade
- Be patient and have faith
Trade frequency
Lets say you are typically used to finding 3 to 5 trade opportunities per day, which is about what our short term trading provides us with. In this random noise environment there are actually far fewer real opportunities than normal. Maybe just 1 or 2 per day – if that even.
However noise has this wonderful way of tricking you into thinking you can see opportunities that in reality are totally fictitious. If you are not careful you will get lured into making MORE trades than normal rather then LESS. This is why such environments are so very dangerous and the long term fate of many traders is determined by these very periods.
So my simple logic says that if the number or real opportunities are fewer per day then our number of trades per day must be scaled back. So the solution is to go into the day knowing IN ADVANCE that your number of trades will me a maximum of 50% of the number you would usually expect. Instead of 3 to 5 plan on taking 1 or 2 only and certainly not the 5 to 10 or more that the noise will try to fool you into thinking exist!
When you think you see an opportunity, here’s what you do. Get up off your chair, walk to the back of the room and look at your chart from there. If you still see a nice clear trade set up, take it. If all you see from the back of the room is noise then that is exactly what it is! Sit back down and do nothing except watch the market quickly move to the place you would have put your stop! Trust me on this after years of gathering scars to prove how misleading noise can be, I have taught this crazy little technique to many people who all swear by using this “filter” to keep themselves out of trouble.
Trade risk
Over the years I have heard many people talk about the secret to trading noisy markets is to use wider stops – to keep the stops outside of the bandwidth of the noise. Sounds logical right?
Wrong! Absolutely dead flat out wrong! Try it if you like, but in practice you will find that for the very occasional trade that you might get away with without getting stopped out there will be ten that still stop you out just for larger amounts than usual!
The big mistake in the wider stop approach is that it assumes a degree of predictability to the noise and hence the argument that you can keep stops out of reach by assessing the bandwidth of the noise. But by definition noise is UNPREDICTABLE that is why it is just random motion.
So my solution, contrary to popular opinion, is to do quite the opposite. I use stops that are much tighter than normal. I give the market about half as much room to perform as I normally would.
You might be thinking “Simon that’s crazy, you are putting you stop right in the thick of the noise so it is certain to get hit!” Yes you are right, but only if your premise is based upon the need to stay outside the bandwidth of the noise. But that is where you and I would have to disagree. My premise has nothing to do with the bandwidth of the noise, I think that is a classic red herring.
My premise is quite different – If the trade is going to work it needs to work immediately. It isn’t going to hang around. Either it does what I expect and just goes, or else I don’t want it! So in a noise environment I give any trade far less room and far less time to prove itself. Because if it hangs around – then isn’t it true that we are still just in noise and the opportunity is in fact bogus?
If it is bogus why do I want to risk a full unit to find that out, let alone a larger unit than normal? Sorry but for me if it doesn’t do what I expect immediately I just want to get out for a tiny cost and be able to say I tried but it didn’t work.
Patience
The hardest part of my formula and the hardest part of all trading is having the patience to wait until a worthwhile opportunity materialises. Gaining the skill of patience is hard work, no question about it. But let me give you a couple of little incentives to think about when you are feeling the urge to click that mouse.
If you follow the guidelines above, i.e. cutting by at least half (if not more) the number of trades per day and the risk per trade, you reduce your daily risk by at least 75%, probably a lot more. Realistically your worst case risk per week in this dangerous environment is now no more than you would be risking per day in a decent environment.
This buys you time to ride out the rough patch without doing much too damage to your capital and this is before we even talk about the option of cutting back trade size (a topic maybe for another time).
Buying time and keeping losses under control is critical for the following reason, aside from keeping your sanity…
When it all changes and comes good again, would you prefer to spend most of the good time making up some dirty great drawdown which was largely avoidable, or would you prefer those new profits to be propelling your equity curve to new highs almost from the start?
I have done both, many times, in my career and I know which one I prefer. So when I look at my short term trading results over the last few weeks and say to myself “damn it we haven’t made any progress recently” I quickly remind myself “yes but we are only a couple of decent trades off of equity highs and THAT matters!”
These are the factors I think about more and more and as you engrain such principles deeper into your mind, the easier it becomes to summon up the patience that every single trader on the planet struggles to have.
Better times are coming
As I mentioned at the beginning we will see better times again soon. Quite when is anyone’s guess.
Every time we hit these patches it feels like “this time is different it will never improve”. Yet over history it always has. Every time we see these nasty markets there is a reason why it may never recover. Every time it does.
There is no getting away from the fact that we live in uncharted times in very many different respects and there is every reason to argue that “it will never be the same again”.
Personally I believe that it will be the same again at some time, but that even if it wasn’t I would still find a way to align myself to the markets to make steps forward once again. Half that battle is avoiding taking too many steps backwards during the tough times.
I suspect the timing of the pick up will be a lot to do with the turn down in equity markets. Historically that is when volume and volatility come flooding back into not just index futures but so many other markets too.
Of course when that will be I also have no idea. It will be when it will be and when it does ranges should expand again, volume should return again and those who have followed the guidelines above will be pushing new equity highs within the first few trades.
For what its worth our longer term model is now short the S&P from the 1350 area, which may offer a glimmer of hope but there is no knowing in advance if the trade will work out or not and if it does there is no saying that this will be any sort of turning point. But it just might be the first sign that the tide is turning as we haven’t had a short signal for a very long time now.
My great friend George Kleinman taught his “secret indicator” at our seminar last summer. If you were there you might like to take a look at the daily Nasdaq chart, which is rather tantalisingly also showing a short signal there.
Will either trade turn into anything more than a scalp? Who knows, certainly not me. It’s just my job to take the trades and the market gives us what it gives us. But one day the trend will change and my guess is that will be the time that the short term trading game will come back to life once again.
Take care of your capital, try not to be too frustrated and have faith that things will get better. We’ll all ride out this storm together.
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Copyright © Simon Townshend Ltd 2012, all rights reserved
Beware of news…but be aware of what it can tell you
The stock market was potentially in big trouble from the day they caught bin Laden.
No I’m not joking here, I’m actually being very serious. For over a decade now it has been accepted wisdom that the most bullish news that could hit the market would be catching the worlds most wanted man.
“The day THAT happens the market will just explode north and never look back.” I cant remember how many times I have heard those or similar words, since the atrocities of 9/11. And lets face it 9/11 did have quite the opposite effect, sending markets spiraling into the abyss.
So on Monday May 2nd we hear the news that conventional thinking said would trigger this rocket in equity values. We buckle up ready for the ride and watch with amazement as…
Nothing happens!
True the market was up briefly for a few hours that Monday morning before it closed down on the day.
So the next day, on Tuesday, there I am asking the traders in my group…”Where is the Osama rally then?” No one knew.
With hindsight this was the short signal of the year. But sadly we cant trade hindsight, even though bizarrely from that Tuesday onwards we had all been openly talking about the “Osama Top”.
Well now we can see from the chart above that the capture of bin Laden nailed the top in the stock market to the absolute very day. How stupid not to have just shorted it right there and then. Why didn’t we?
Well because we didn’t actually have a sell signal from our normal trading strategy and we are always fighting to follow our rules. That is true but also makes good cover for the other truth that secretly we were scared that the “rally of a lifetime” might just come about as all the experts had foretold for the prior ten years!
There can be no doubt that this was one heck of a missed opportunity. If I am honest we should have been bold and just stepped right in when the market failed to rally. No we didn’t have a sell signal in the normal sense. But we did have the biggest tip-off of all…
The fact that a market failed to rally in the face of the most bullish news it could possibly have received.
Now THAT is a sign of a market in serious trouble. Failing to respond positively when it had every reason to do so spelled the end of this cycle’s irrational exuberance!
This recent sell off didn’t just appear out of nowhere a month ago. It is purely a continuation of the new trend that started the day the market signaled that the bull market was done for, by failing to gain any ground at all when it should have exploded.
The market was telling us that the game was over. We just weren’t smart enough listen. Or to be precise we were smart enough to listen, which is why 24 hours later we were already talking about the Osama Top. But we weren’t smart enough, on this occasion, to react to what the market was telling us. This was an expensive mistake, even though we were following our trading rules by not taking any action.
The moral of the story therefore is simple…
A market that fails to rally in the face of exceptionally bullish news, is in serious trouble and has run out of steam. A market that fails to fall on exceptionally bad news, is in fact very strong and is likely to be turning up very soon. This strength or weakness is hidden from view but the LACK of reacting in the way it really should be in extreme circumstances is without doubt a genuine tipoff about what is about to take place.
Remember though a missed opportunity is only a missed opportunity if we fail to profit from it OR fail to learn from it. In this case we’ll treat this as an educational expense rather than a disaster!
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Copyright © Simon Townshend Ltd 2011, all rights reserved
The power of the close…worth waiting for?
Most of my trading signals are triggered at the close of a bar. I have also noticed that the close is an important factor that many successful traders insist upon before entering a trade.
Yet for most of us there is a real temptation to want to jump is as quickly as possible when we see a setup forming. This seems like the natural thing to do. After all we have been waiting all day perhaps for this moment, so we don’t want to miss it and why wait to enter at what will probably be a less good price by the time the bar actually closes. So let’s just jump straight in!
But hold on a minute. If the bar close is the official trigger to enter the trade, that was probably selected for very good reason, wasn’t it? If so than we need to be patient and control our urge to just get in.
What’s the big deal?
Instinctively we know about the importance of the bar close after years of observation. So what is it about the close that is such a big deal?
Well there are several reasons to consider using the bar close as an entry trigger. These include – noise, stops and sometimes volume.
Markets are full of noise these days. Quick sharp spikes that spontaneously reverse as price gets straight back to where is was a few minutes earlier. These can be caused by all sorts of factors – big orders exceeding available liquidity, reactions to news or rumours etc.
Think of stops as food!
Markets also thrive on volume. That is what they are always hunting for. That is what the industry relies upon. Obvious areas where people place stops are therefore targets. If the market can probe such an area stops get triggered and, well, that creates volume doesn’t it? Volume is how the market feeds itself!
So when traders always say that “they” are gunning for our stops, there is a degree of truth in that statement! It is also a reason why in my trading own I try to (a) identify those areas where the market is likely to be stop hunting and (b) not to place my own stops in obvious locations!
Gaining another little edge
Now if trade rules require entry on the close of a bar rather than just at an entry price, to some degree it is possible to avoid getting trapped by such spikes. For example imagine a quick spike that lasts for say one minute. By entering on the close of a five minute bar, rather than at a price level, the risk of entering on a spike rather than a valid trade is reduced. It is not eliminated, but the chance is reduced from 100% to 20% in this example. Its not perfect but if the price of avoiding 4 out of 5 such traps is a little patience, that might be a virtue worth developing?
In the case of daily bars there is an additional factor to consider. If a market is able to hold onto a price level attained during the day, after the heaviest volume of the day has already been transacted, the likelihood that that price level is significant is greatly increased, and this is important information (whether most traders are aware of it or not!).
These are just a few of the reasons why professionals often utilise bar closes when developing trading strategies. It isn’t some earth shattering revelation, but just one of the many tricks a trader can use when seeking an edge in the markets. Ultimately in a business where there is no certainty, no right and no wrong, gaining an edge in any and every way we can is a route to better performance.
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Copyright © Simon Townshend Ltd 2011, all rights reserved
Head & shoulders top…achieves minimum objective
Well it took a long time to form, but when it triggered boy did it run! Hmmm, but maybe there is more than just one force at work here?
George and I have been following the weekly chart of the S&P over the last few weeks, watching that classic head and shoulders pattern form. Yesterday the minimum downside objective was achieved. Pretty cool reaching a target of that magnitude within 2 bars eh?
Now classical chart patterns are not something I would claim to be any great expert in. But George likes the head and shoulders for the simple reason that it is about the most reliable of the “old school” pre-computer age setups.
The spice I would throw into the mix here, is my observation that the down move is a 1-sided market. Those who joined us for the seminar in Santa Monica a few weeks ago or who have worked with my behind the charts technique will know exactly what this means and its implication on the future.
So here is a great example unfolding where an age old technique and a modern day discovery are working hand in hand to create a really powerful combination.
If ever there was a certainty in trading it is this: After the dullest of dull starts to the year, exciting times lie ahead! Just remember that expanding volatility means much larger swings, which means much larger stops and much larger targets. In turn that means much smaller size so as not to increase your dollar risk per trade!
It is true that higher volatility means greater opportunity. But that greater opportunity should come from a greater number of trades and NOT from trading the same unit size with increased dollar risk per trade. Remember money management rules always take precedent over trading rules. So enjoy the great times ahead but keep a level head at all times!
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Copyright © Simon Townshend Ltd 2011, all rights reserved
Bubbles always burst eventually
That bubbles eventually burst is as certain as the sun rising every morning. However timing the blowup is rather less easy than timing dawn breaking. But there are telltale signs to be on the lookout for.
Following yesterday’s article in which I included that rather hair raising chart of Silver’s recent collapse, I was reminded by a friend of an article I wrote a year or so back in which I spelt out the precursor to many such dramatic reversals. Therefore I decided to reprint that same article for you below.
First of all here is yesterday’s Silver chart overlaid with the same indicator discussed in the article below. Look familiar?
Spontaneous Reversals – Impossible to Predict?
In theory if something is spontaneous then by definition it is impossible to predict. But that doesn’t mean that we cannot spot the telltale signs that often precede “the unpredictable”. As always with the markets the key is in understanding what lies behind that which is visible on the surface.
So let’s look at a spontaneous reversal, or as most people refer to them – the V-reversal.
In Financial Physics we specify 3 ways in which a new trend may be born. Of these the least common (by far) is the V-reversal – where a market just spontaneously turns ending one trend and instantly starting a new one in the opposite direction.
As well as being rare such new trends are extremely difficult to anticipate. Difficult yes, but not totally impossible 
. That is why a few days ago I included the following excerpt in my daily update sent to members of my S-I-R service:
So we were all on notice that the stage was set for one of these unusual events and hence in our shorter term trading to switch to playing the short side of the market. I also promised to write an article explaining more about this situation. So, here I am going to show you how we knew to switch to the short side days in advance of this rather impressive, and theoretically unpredictable, spontaneous reversal:
The What, the Why and the How
I don’t have room here to explain why this works, but I will show you exactly what to look for – the telltale signs, so that you will know in future what to watch out for. My suggestion for how you might use this insight is mainly as a filter rather than as a trade setup. So next time you see this you will know NOT to consider buying pullbacks etc.
As well as knowing when not to buy pullbacks, there is also a way to use this to trade against the prevailing trend – shorting in this case. But this is only for those who are highly experienced with this technique and I am not able to share that here. It is extremely aggressive and you have to know exactly how to play it.
But if this insight just keeps you out of one losing trade in future than I will regard it as being worth my time writing this. (For my S-I-R members I will elaborate further next weekend on both why this works and how to actually trade it, as I promised you previously.)
Right. What we need to look for is a market (any market and any timeframe) where a trend is underway that meets these criteria:
- A low volatility trend (lots of small overlapping bars moving strongly in one direction)
- No swings within the trend (just a single, painfully slow straight line crawl)
- The whole trend taking place displaced from its mean (see chart below)
Here we can see a simple Keltner channel added to the same S&P daily chart. (The parameters are largely irrelevant but as I know I will get asked – 21 period exponential moving average and 2.25 ATRs are the settings used here.)
Notice how this trend consisted of a single low volatility crawl along the outer band. This is not the usual series of swings and waves, but one single move. Note that moving along an outer band is critical here – this means that the move is displaced from its mean. If it was just a crawl along the moving average the situation would be totally different.
This action is rare, yet whenever you see it you will find that it very frequently ends with the hitherto totally unpredictable V-reversal – hence you don’t want to go buying pullbacks!
Have a rummage through your charts – look at different markets, various timeframes, etc. You won’t find many examples but you will be amazed at just how many of them end in a spontaneous reversal.
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Copyright © Simon Townshend Ltd 2010, all rights reserved
Great days ahead, but bide your time!
Did you watch the events of yesterday unfold in disbelief? Spectacular wasn’t it?
- Crude dropped almost $12 in one day to close back in double digits once again
- The Dollar Index made its biggest one day gain in months
- Silver extended its losses to close the week down a whopping 30%…
Dramatic moves, but this is wonderful news for traders as these events act as a stimulus to get things moving again, for new trends and new cycles of trade setup to develop. It is no secret that the start of 2011 has been marked by lots of chop and instant changes in sentiment. This is not uncommon at the end of trends and is a tricky environment to navigate.
But from this sort of action new trends can be born that provide new opportunities for many weeks and months to follow. So look forward to easier times ahead.
However, be careful for the next few days. We all have the urge to jump right in and want to make up for lost ground. It is difficult to be watching from the sidelines at these times. But there is no hurry! The opportunities will be abundant for a long time after the initial shock kick starts flaky markets. So there is no need to be in there fighting on day one.
The first 2 or 3 days after such an impulse can provide huge opportunity. But they are extremely difficult to navigate. New volatility levels have to be adjusted to and the markets always over react making short term sharp reversals likely. So the chances of getting into trouble are also much higher.
My advice is to let the dust settle before getting too actively involved. Play the long game. Make great use of the new cycle of clean swings that will unfold over the coming weeks and months and remember that Rome wasn’t built in a day! We have waited all year from some sort of impulse, so another day or two of playing it cautiously isnt going to hurt at all.
Then once the dust has settled that is the time to really set to work.
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Copyright © Simon Townshend Ltd 2011, all rights reserved
Combining Disparate Timeframes
A popular topic in trading circles is the use of multiple timeframes. Lots of traders like to use more than one timeframe to support their hypotheses and used properly such techniques can have considerable benefits.
However most proponents use relatively similar timeframes and in my opinion in doing so they are missing the true value of such an approach. I like to use truly disparate timeframes, ones that are radically different to each other.
Copper last week gave us a timely example of this, so let’s use a real life example to illustrate the power of this often misunderstood concept. We will start with a daily chart of copper…
Our strategy gave us a buy signal at 435 shown with the red arrow, which we duly entered and we are still holding the bulk of the open position. Actually our own buy signal was in fact supported by a more traditional technical feature on this same daily timeframe…
We can see an attempted downside break from the longer term chart formation a few weeks ago. A failed breakout can often lead to a much more impressive assault on the other side. So in this case the breakout to the upside which came the day after our buy signal could be expected to perform well.
So once we had a daily buy signal its next a case of trying to limbo in at the best possible price. To see this we drop down to an hourly chart, obviously a much smaller timeframe…
After the daily buy signal we actually entered overnight with a resting order as shown by the red arrow. What can we see here on this hourly chart? Here we have a simple little bull flag providing a nice lower timeframe entry into our main daily setup.
Sadly these things don’t set up perfectly as frequently as we would all like, but we are regularly talking in the chat room about looking for hourly entries into longer term positions. Why? Think about it from a Risk/Reward perspective. If you can occasionally combine the risk of an hourly trade with the reward of a daily trade – this is something to be played for any time such an opportunity shows its face!
Finally let’s look at the weekly copper chart…
Oooh! Now we have a weekly bull flag and with a little luck this may be ready to start kicking in for us. Only time will tell. But what I do know at this early stage is that an hourly entry into a daily set up with even the faintest possibility of capturing a weekly move – this is trading utopia and is the sort of thing that all professional traders should always be on the lookout for.
I know many traders like to use combinations of 5 minute and 15 minute charts, or hourly and 120 minute charts, etc. While there is nothing wrong with that per se, the real advantage of multiple timeframes is to be gained from the correct use of radically different timeframes.
We will be exploring the power of disparate timeframes at our seminar this summer. Are you ready to put a range of clear cut, logical and practical techniques to use in your trading? If so be sure to join me, George Kleinman and Jeff Quinto for this one time, one day event as we share the secrets gained from 100 years experience in the markets.
A maximum of 50 people worldwide may join our private clients at this exclusive event. If you are ready to take your trading to the next level, please reserve your place before this event is advertised to the general public. I hope you can join us for a truly revolutionary day… www.CenturyOfTrading.com
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Copyright © Simon Townshend Ltd 2011, all rights reserved
By the time you spot a bandwagon…
…it has probably already passed you by!
Those were the famous wise words of the rather flamboyant financier Sir James Goldsmith. Well this week the wheat market became one of those bandwagons. I know this is not a market that every reader of my articles will be following, but it provides such a good lesson in trader psychology that I want to spend a few minutes today discussing it.
Over the last few weeks this market has been having a spectacular bull run and in the last few days it went parabolic, as you can see in the chart below:
You may recall a similar thing happened in Sugar last year and I discussed that market at the time. Today’s story starts on Wednesday, 2 nights ago, when like many people I watched the evening news and heard all about the terrible fires and devastation in Russia. The loss of 25% of the wheat crop was a considerable chunk of the report. “OK time to take great care in Wheat” was the first thing that went through my mind. “The great unwashed will be going shopping tomorrow stoked up by the media reports” was the second thought that went through my mind.
True to form Thursday saw the wheat market close limit up as everyone scrambled to climb aboard the bandwagon. On Thursday night I mentioned to my closest friends that this market could run a lot higher still, but to be careful as such moves end just as spectacularly as they begin. You never want to consider continuation trades in a parabolic market and nor do you want to start fading them until after they have turned. In fact unless you have a lot of experience with these types of moves you just don’t want to touch them at all.
So today there was another huge run up in wheat as the last of the desperate buyers emptied the last of their available money into this market chasing the dream that it would continue climbing to the moon. What the less informed masses fail to grasp is that the move up is only sustainable for so long as they have money to drive it up themselves.
But the minute the buyers run out of money there is nothing left to drive it any further and inadvertently they then become the architects of their own demise. Sadly I was away today so missed all of this classic saga unfolding. But I found it telling that the market ran up again early today, almost to limit up, but not quite. It then traded sideways for many hours just a few cents below limit up. In other words there was no artificial limit placed on the buying today – the bulls were able to buy everything that they wanted. In fact they were able to buy so much that they finally exhausted their reserves. With no more money available to come into the market it duly turned down, put a top in and closed limit DOWN!
Every single person who bought in the last 2 days (i.e. after the big news report) is now not only holding a losing position, but trapped in a losing position. Once the market was locked limit there was absolutely no way for these people to sell back out. They were late to the party and are now locked in for the weekend, at least.
Do you think they’ll be sleeping well tonight? Do you think maybe there will be a pile of “sell market on open” orders being prepared over the weekend? The market closed at 726 after some poor soul paid as much as 841 just a few hours ago. Now that looks suspiciously like a brokerage statement that will shortly be framed and hung on the wall next to all the dotcom share certificates!
Lots of trapped new players, is often the recipe for a massive squeeze. Do you think they’ll get out at 726 when the market opens on Sunday night? Or does it seem more likely that there will be a huge gap? It’s going to be ugly for them either way, so the debate now is only one of magnitude.
For us it is just another reminder of some very important lessons:
- How and why markets actually turn
- How the majority will always be on the wrong side at significant turning points
- The media’s role in driving such events
- Why we never want to chase a market, nor touch a market that has gone parabolic (until after it turns)
[As a quick aside for those that use my Behind the Chart technique, take a look at the hourly wheat chart today – a picture perfect short just above 800, with no heat and a straight line move to limit down. As I said in the webinar the fade trades are always the best ones, they just aren’t as frequent as we would like.]
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Copyright © Simon Townshend Ltd 2010, all rights reserved
The storm clouds are gathering
I want to start this article my pointing out that I am no economist, just a humble engineer with a half logical but inquiring mind. Not that I place much faith in the predictions I have seen from proper economists over the years!
Anyway having recently been studying the copper market where we missed a very nice short trade, I was suddenly struck by something unusual – a huge divergence between copper and gold has been developing over the last month:
Notice how these markets usually follow a very similar path? Sure the amplitude of each swing varies, but the general direction tends to be the same. Until all of a sudden about a month ago this changed fairly dramatically.
When an established pattern suddenly changes my interest is aroused as it means that “something” is going on and the market is trying to tell us something. Well actually the market is probably trying hard not to reveal its secrets to us mere mortals, but it cannot avoid leaving its footprints behind for those that are looking.
What do we know about these two markets? Well gold is a long established hedge against inflation. For decades it has been the place for people to put money when they fear inflation which is of course a mechanism for devaluing cash. (In practice it turns out that this gold instead of cash strategy doesn’t actually perform anything like as well as we might believe, but that is another story altogether.)
The copper market has become something of a proxy for economic activity over more recent times as our lives have become ever more dominated by consumer and electrical goods, computers, phones etc. Everywhere you look these days, you will find copper. Actually I would argue that it is more a proxy for discretionary spending rather than the purchase of essentials like food. But that is probably a mute point.
So what might this sudden divergence between these markets be hinting at? Gold continues its upward march reminding us of the looming inflation threat that clearly in not abating but becoming an ever closer reality. Indeed UK inflation figures just released showed CPI already at almost double the 2% target figure and RPI at a 20 year high at well over 5%. So here at least the penalty for all this printing money madness is no longer a threat but already becoming a reality.
Of course economists and politicians made a big thing about this recession being so different from the past due to the absence of inflation and how much pain we were spared as a result. So no doubt these oracles will be relieved to be out of recession (apparently!) now that inflation is set to strike?
Well not so fast please, let’s not forget this copper market. If this proxy for economic activity is to be believed (and who knows?) this market seems to be seriously pricing in a fall in economic activity. A 20% decline in copper prices in a month is more than just noise. Most of the traders I speak with (and what the heck do we know!) have been taking a double dip for granted. The debate that rages here seems to be “2 dips or 3?”.
So let’s see then – we have:
- no jobs (and unemployment still rising)
- no growth (and quite possibly negative growth ahead)
- inflation (at some point interest rates will have to be raised)
- debt of unimaginable scale (and no realistic prospect of reducing it currently)
Forgive me for being pessimistic but this looks to me like the perfect storm brewing and it is not just the markets hinting at this possible scenario. Uncanny isn’t it that yesterday we had the SEC proposing tightened circuit breakers in the stock market to prevent crashes (like limit moves don’t suddenly become targets for traders!) and today Germany implements a 10 month short selling ban (which they will also try to rollout across the rest of Europe too).
Do you think maybe these guys are trying to get ahead of the game this time? An interesting few months ahead of us I suspect.
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Copyright © Simon Townshend Ltd 2010, all rights reserved
Spontaneous reversals – impossible to predict?
In theory if something is spontaneous then by definition it is impossible to predict. But that doesn’t mean that we cannot spot the telltale signs that often precede “the unpredictable”. As always with the markets the key is in understanding what lies behind that which is visible on the surface.
So let’s look at a spontaneous reversal, or as most people refer to them – the V-reversal.
In Financial Physics we specify 3 ways in which a new trend may be born. Of these the least common (by far) is the V-reversal – where a market just spontaneously turns ending one trend and instantly starting a new one in the opposite direction.
As well as being rare such new trends are extremely difficult to anticipate. Difficult yes, but not totally impossible . That is why a few days ago I included the following excerpt in my daily update sent to members of my S-I-R service:
So we were all on notice that the stage was set for one of these unusual events and hence in our shorter term trading to switch to playing the short side of the market. I also promised to write an article explaining more about this situation. So, here I am going to show you how we knew to switch to the short side days in advance of this rather impressive, and theoretically unpredictable, spontaneous reversal:
The What, the Why and the How
I don’t have room here to explain why this works, but I will show you exactly what to look for – the telltale signs, so that you will know in future what to watch out for. My suggestion for how you might use this insight is mainly as a filter rather than as a trade setup. So next time you see this you will know NOT to consider buying pullbacks etc.
As well as knowing when not to buy pullbacks, there is also a way to use this to trade against the prevailing trend – shorting in this case. But this is only for those who are highly experienced with this technique and I am not able to share that here. It is extremely aggressive and you have to know exactly how to play it.
But if this insight just keeps you out of one losing trade in future than I will regard it as being worth my time writing this. (For my S-I-R members I will elaborate further next weekend on both why this works and how to actually trade it, as I promised you previously.)
Right. What we need to look for is a market (any market and any timeframe) where a trend is underway that meets these criteria:
- A low volatility trend (lots of small overlapping bars moving strongly in one direction)
- No swings within the trend (just a single, painfully slow straight line crawl)
- The whole trend taking place displaced from its mean (see chart below)
Here we can see a simple Keltner channel added to the same S&P daily chart. (The parameters are largely irrelevant but as I know I will get asked – 21 period exponential moving average and 2.25 ATRs are the settings used here.)
Notice how this trend consisted of a single low volatility crawl along the outer band. This is not the usual series of swings and waves, but one single move. Note that moving along an outer band is critical here – this means that the move is displaced from its mean. If it was just a crawl along the moving average the situation would be totally different.
This action is rare, yet whenever you see it you will find that it very frequently ends with the hitherto totally unpredictable V-reversal – hence you don’t want to go buying pullbacks!
Have a rummage through your charts – look at different markets, various timeframes, etc. You won’t find many examples but you will be amazed at just how many of them end in a spontaneous reversal.
Disclaimer, risk warning and copyright notice apply to all articles published on this site.
Copyright © Simon Townshend Ltd 2010, all rights reserved
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