Thursday, 16 May 2013

How to Get with a Streaking Market

Ralph Shell, Excel Analyst

There is nothing more discouraging to a trader than to correctly analyze a market, and then watch it streak away without you.  Markets often have false starts, and then settle back to the congestion area where they started.  Buying the break out with an appropriate money market stop often results in a series of losses.

Sound familiar?

We then change our strategy.  Rather than buying a break out, we decide to buy on a pullback into an area where there appears to be support.  This might be a Fibonacci number, or it might be an area in which there had been numerous trades.  But there is a problem with this approach.  If our analysis is correct - that a market is headed higher - the probability is that the market will not sell off to the ideal buy price.  In other words, the strong market will rarely give you the ideal price to buy.  Other trading systems will recognize the pattern, and buy orders will accumulate there.

Once you have acquired this long position at your predetermined bargain price, it is then time again to again analyze.  Have market conditions changed, or is the market sell-off merely random market noise?  If you have correctly selected a pullback entry point, in a bull move, the market action should quickly prove you correct, and put some funds in your account.

The market continues its rally, and it then approached the old high where you had previously bought and subsequently been stopped out.  Fearful this might happen again, you exit the market, taking some nice profits.

The market then breaks out, storming toward what had been our longer-term objectives, as you watch from the sidelines.  They say no one is as bullish as a sold out bull, but are you really willing to pay any price to get back on the long side?  Chances are the average trader will look to buy back the position at the old high, which is now the new resistance. 

Remember, though, a truly strong market will not give you the ideal entry point.

One of the tools that you employ to locate an entry point are the Bollinger bands.  The daily USDJPY chart is helpful.  The bands we have constructed are two deviations from the center red line, or the 20-day simple moving average.

Click to Enlarge USDJPY Daily Forex Chart

Note the market first broke above the 20 day SMA on November 14th when the high for that day was 80.30.  It was not until January 23rd when the pair next traded at the 20 day average, and then it merely touched it.  Here we see the example of a very strong market.  The longer this market goes sideways, the greater are the chances it is consolidating to make a new high. 

During the bull run from November to May, there have been five opportunities to buy the pair at the 20 day SMA.  Without too much draw down each of these positions would have been profitable.  The position could have been held or you could have taken profit when the pair again traded at the upper deviation line.  Another trading option is to liquidate when the market moves up seven days in a row.

The COT Report combined with the daily currency volume traded at the CME can provide useful information.  Looking back on March 26th, the AUDUSD was trading well above 1.0450.  At that time, the COT report showed the specs to be long a massive 97,517 contracts.  From then until the last report taken on May 7th, the market did not work out for the longs.  They got out, taking the pair down to 1.0255.

Click to Enlarge AUDUSD Daily Forex Chart

On the May 7th report, the specs were still long a net of 5,197 contracts.  As the longs liquidated the open interest in the futures market plunged to 154K contracts on that day.  The market continued lower, trading today, just under the 98 handle.  The interesting thing is the open interest in futures has gone up from the 154K to 200,286 contracts in just over a week.

We will not know until the next COT report comes out Friday, but my guess is the same specs who were long at the top have now gotten themselves short at the new low.  The move from long to short has extended the move.  Now, when the A$ selling stops, that currency may be due for a rally.

These are just a few trading tips that will hopefully assist you in managing your account.
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