Some commentary on the Irish Situation.

Good morning.

My first week for some time of non-blogging, and a very interesting week its been. The Irish/European Crisis seems to have come to a head (for now), and the markets saw some very strong corrective activity, which has certainly helped to de-froth them, particularly in the wake of the QE2 announcement.

In line with my earlier comment from this week, where I announced I will be slightly stepping back from daily blogging, I still intend to occasionally update my page, including a weekly blog at least. I hope to get some analytical stuff out on Monday. For now however I would like to post (or refer) to a couple of articles from other contributors.

The first posting is by NAB economist, and ex-colleague of mine Nick Parsons. Nick is a brilliant economist who has great understanding of markets from both an economist's angle, and having worked closely with traders for many years, a trader's angle. His commentaries and writing style are wonderfully perceptive, witty, and slightly acerbic, all at the same time. Here is his commentary for today (19th Nov):

As millions of freckle-faced, tousle-haired Irish kids set off for school this morning, they’d be well advised to pay attention in their German lessons. It might not be a bad idea to stay awake during Economics too, and they might even find basic Mathematics comes in pretty handy. Their parents’ generation, unfortunately, spent too much time in Politics and Creative Writing classes whilst making the elementary mistake of studying History but failing to learn from it. We have the laughable but tragic situation today of hearing Irish political leaders insist on what is non-negotiable as if somehow they will ultimately have any say in the matter. To be sure, it’s the only bargaining tool they have and they might as well use it, but threatening to bring about the collapse of a European project which has been more than 60 years in the making will cut no ice in Brussels or Berlin. Dressing up a sovereign bailout as a mere accounting issue, a technical plan to provide a loan to the banking system, should fool no-one. Crucially, it’s unlikely to impress the European Central Bank, which is finding its mandate to ensure price stability increasingly undermined by a new requirement to become the lender of first resort to a bankrupt system. The Frankfurt-based ECB is likely to be headed next year by a German central banker. This will be the minimum price for German acceptance of a commitment to underwrite the EFSF for what could become perpetuity. The German economy is booming and a German-led ECB in Germany will increasingly set interest rates for the good of Germany. So it’s not just the Irish who should concentrate in school today. The rest of Europe, like it or not, is likely to find out soon that real power lies with creditors, not debtors.

The second article of the day is from the 'Daily Telegraph' newspaper. The Telegraph is the most widely read of what are known as the Broadsheet newspapers here in the UK: These include -'The Times', 'The Financial Times', 'The Guardian', and 'The Independent'. The article is entitled 'Margaret Thatcher knew the single currency would devastate Europe'. and can be viewed by hitting the highlighted link. I have always considered Margaret Thatcher as the greatest British Prime Minister during my lifetime - by a country mile. However she and many of her followers have often been maligned in the British press, yet she was one of that rare breed that had the courage of her convictions and did what she thought was right for the country, not what was popular, or right according to the opinion polls and columnists.

I think if you read the piece fully you may appreciate our lucky escape here in the UK, and although Margaret Thatcher fell from power in the early 90s, I think her influence and opposition at the time to joining the Euro built up enough of a head of steam to ensure that it never materialised in the ensuing years. In fact looking now at what is happening a short hop across the Irish sea from us, I can't helping thinking that joining the Euro may have achieved for Germany over the UK what 2 World Wars failed to achieve.

At that point I will bid you all a great weekend. 

Less Regular Blogging.

Dear readers and fellow traders.

Just a short notice to inform you that I will no longer be providing regular updates on a daily basis. I have recently become involved in a new project (related indirectly to trading), which is growing and now constraining me time-wise. I will continue my own trading (which I doubt I'll ever stop), and I will try and provide occasional updates. However, this will almost certainly mean many of you will probably cease stopping by on a regular basis. - Therefore may I say I would like to thank you for following me, and allowing me to publish this blog, which I have enormously enjoyed doing, and I wish all of you the best of luck in your own trading endeavours going forward, whatever they may be.

Regards

Gooner70

The PIIGS and Risk aversion - The sequal.

Concerns over European Sov Debt continue to rattle these markets. Irish 10 year yields are pushing close to 9%, to put some perspective on that just two weeks ago they were below 7%. The Irish contagion has spilled over to other PIIGS as CDS prices have risen strongly for Portugese, Spanish and Italian govt bonds. Meanwhile traditional safe-haven currencies USD, Yen and Swissy are outperforming the Euro and the risk orientated currencies such as the AUD. - Stocks have been wavering through the week, however overnight futures markets have seen heavy losses, and the risks are growing of a much deeper setback. The chart below is the SP500 e-mini futures over the past year. I have highlighted strong similarities between the period Dec 2009 to May 2010, and the period over past few months, the likeness is almost uncanny. - If history were to repeat itself here, (or more to the point rhyme), then things could start to get very ugly. The runaway train which was the SP500 last week may now be getting ready to come of the rails.

Something for the weekend:
Here in Britain, these rain-swept islands perched off of the North-West coast of Europe, we have generally been deemed largely irrelevant in the great race into space. The first country to send anything successfully into space were Germany, unfortunately for us in the UK, we were the intended target, with most of Germany's V2 rockets falling back from space and on to London. Since then the US, Russia and China have all managed to send people into space, plus the odd dog and monkey. We did try sending a probe to Mars a few years back, but we don't think it ever actually got there. -  Finally however, I am very proud to report that Britain finally has a space first, something which has been achieved at a mere fraction of the cost of the many Billion Dollar programmes achieved by other nations. Britain has become the first nation to put a paper plane into space. The story can be seen by hitting this link.  -- So lets hear it for British genius, ingenuity and inventiveness, and from now on, whenever you think of nations pertinent to space exploration, please remember to include Britain very firmly on that list. 

Have a great weekend .........

Other markets may be pointing to equity correction.

The past 24/48 hours has seen some big swings on Bonds, FX and Equities, though ultimately in many cases they have not actually move that far. The US has a public holiday which may induce a calming effect on markets for today. A few notes on a couple of themes I touched on yesterday:

GBPUSD FX bounced strongly, and has broken the 1.6135 area which I thought may cap it. The strong bounce has also kept the Cup + Handle pattern scenario alive, though the '3 Black Crows' patten I highlighted yesterday still weighs heavily on this, for now I would like to sit back and see how this develops and whether the 1.6200 area can cap this for now.

EURUSD FX continues to under perform, linked closely to shenanigans occurring on the periphery of the Eurozone. Although it overshot the 1.3700-1.3800 support zone yesterday, it did not proceed too much further, and I think this zone may still offer some support, however the ease with which 1.3700 was broken does not bode well. 


The sustained strength of GBPUSD and recent weakness of EURUSD fits well into EURGBP FX moving lower. A couple of weeks ago this cross rejected the upper line of a large downward sloping trend channel which has been forming over the past 2 years, this suggests further significant weakness may be a theme for EURGBP in coming months (See chart below).

A couple of other developments which may be significant. USDJPY FX may be putting a base in. I say 'may be' because trying to pick or even identify a bottom on the USDJPY is tantamount to skating on thin ice. The chart below is the 2-Day Candle chart over the past 9 months. 

Also the US 10 year yield has possibly completed an Inverted Head + Shoulder pattern, the chart below shows the US 10 year yield daily. If this is confirmed over the next few trading days, yields could push back over 3% in the next few weeks

To summarise, it looks as though some of the trends of recent weeks are under threat or facing corrective forces (EURUSD,USDJPY,10 Year Yields). These markets moved pretty much in tandem with the SP500 rally in recent weeks, if a correction were to take hold on these markets, this may suggest a co-ordinated correction in equity markets over the next few weeks.

SP500 , GBPUSD and EURUSD updates.

Last week I put the idea forward that we may see a 'Buy the rumour - Sell the fact' type reaction to the QE news, however I suggested it may not happen until the payroll data was behind us. It is possible this may be happening, though whether this is part of a bigger bearish turn I have no clue at this stage. First support, and strong support, should be at around 1195/97 where the base of the rising channel since early Sep occurs.

GBPUSD FX

Last week's 'Cup + Handle' pattern breakout may have failed. Yesterday's move has seen GBPUSD move back below the breakout line, although it is only a marginal break thus far. Nonetheless, the speed of the rejection of the breakout, suggests to me at this stage that this may be a valid failure, interestingly it has also occurred as a very bearish '3 Black Crows' candle pattern. Breakout failures can often be more telling and significant than successful breakouts. A sustained GBPUSD break below 1.5800 should confirm the failure, and could set-up a move much lower to around 1.5300. I would expect 1.6130 to act as a firm cap if this is going to move lower. 

EURUSD FX

Short-term the EURUSD may have find support in the 1.3700/1.3800 area, whilst on the 4 Hourly Candle Chart there is some sign of Bullish Divergence on the RSI and the MACD Diff, a correction back towards 1.3900 - 1.4000 can not be ruled out at this stage, whilst a clear break of 1.3700 could suggest more downside to come.

SPAIN IRELAND V SP500

I will keep this short and sweet today... Spain Credit Default Swaps are soaring, as have Irish CDSs been. In recent weeks Greece and Portuguese CDS have soared. The SP500 has shaken these off so far bolstered by QE, it may continue to do that, but I can't help thinking that a lot of good news is now priced in, whilst new global concerns may start to weigh, particularly as Spain is a much bigger fish than either of the other three. The charts below shows Spain and Irish CDS versus the SP500 over the past year, I have highlighted previous periods where CDS prices started to soar and how the SP500 reacted at the time.

My SP500 system passed its summer test. +. EURUSD and Spain worries.

Over the past couple of years I have been monitoring the performance of a 'Trend-Following' system which I created and which I have back-tested going back to 1970. The system faced a major test of its performance this summer, when equity markets went through a torrid correction and phase of up and down swings: Various moving-average indicators (such as the 50/200 Death Cross), and other signals such as the 'Hindenburg Omen' produced Bearish signals.Though my system came close to giving a bear market signal, it ultimately failed to trigger it and retained its Bull Market signal, which was generated in August last year. The system can either be 'Bullish', 'Bearish' or 'Neutral'. I first mentioned my system in a post on the 29th July (Can be seen by clicking here). The system, being a trend following system, is not used to give advance signals, however it does seem to be doing a great job of capturing the underlying trend of the market. Without giving too much away the system is a combination of moving average and trend strength, moderated by volatility and a stop-loss rule. The chart below is the SP500 Index on a Log-Scale from 1970 to 2010, below that is my Bull Marker/Bear Market signal produced by the indicator.

The following is a basic comparison of this system versus the 50/200 cross, Buy and Hold, and 3 year compounded Treasury Yield,I have kept it as simple comparisons. Thus as well as producing a far better return than all these measurements, the system had a much better ratio of winning signals to losing signals on the 50/200 day crossover method; my system had 75% of all directional signals producing positive results, versus 55% for the 50/200 crossover. 

 
As I said the system is trend following not leading, however it does provide a reliable guide to longer-term  market conditions.

Getting away from my system and focusing on the short-term outlook, I believe the SP500 may be vulnerable to some profit-taking. Last week's big news is now out of the way, the April 2010 highs having been hit, a great run-up for stocks since early Sep is now at a mature stage, and elevated concerns of the European Sov Debt crisis are re-surfacing, with all this I can not help thinking some longs may wish to take some chips off the table.  

EURUSD and the EUROPEAN SOV DEBT CRISIS.

Concern continues over the re-emergence of the European Sov Debt Crisis, this continues to undermine the EURUSD. Friday's post highlighted the weak daily structure of the EURUSD on the daily charts, the weekly chart also looks unfavourable for the EURUSD and suggests a possibility of deeper losses to come. I have shown a weekly chart of the EURUSD below, last weeks price action produced a 'Shooting Star' candle. I have highlighted previous 'Shooting Star' candles on this chart.

For the last couple of weeks the Sov Debt crisis has been bubbling under again, I focused on Ireland and Greece in a post a couple of weeks ago whilst Portugal has also been getting much attention. However now the Spanish yield spread v Germany is starting to re-widen and Spanish CDS prices are also pushing up towards their highs of the summer. The charts below show both of these over the past 6 months, technically they both appear to have broken out of a large triangle pattern, which suggests higher levels ahead.

The market, whilst paying lip service, has largely ignored the Greece, Ireland and Portugal woes in recent weeks, however if Spain starts to have problems, then it will have trouble ignoring this, the table below highlights the glaring reason why this would be so.

One final point on the EURUSD, the whole pattern since the June low may be starting to take on the appearance of a '3 Peaks and a Domed House' Pattern (see chart below). As I have mentioned in the past these are very rare patterns but can be extremely dynamic if they follow through. This is one to keep an eye on.

SP500 runaway train, EURUSD faces Sov Debt worries, Trader Psychology and the best Technical Analyst,

The SP500 continues to surge it has the full force of the Fed, and the market trend behind it right now. I don't much care at this moment whether it is overvalued or undervalued, whether its behaviour is rationale or irrational, right now it is a runaway train: If you are not already on the train, then it ain't gonna be easy to catch, however I'd rather be on it than standing in the way right now.

The big event today of course is Non-Farm payrolls, this either has the ability to accelerate the speed of that train, or to slow it down slightly, but I doubt on its own its gonna stop it. Also I am keeping half an eye on the European Sovereign Debt issue, this is bubbling under again, particularly in relation to Ireland, much like it was in April this year. Already this morning the EUR is well off yesterday's highs, I can not rule out the possibility that the EURUSD slips back to last week's lows, or even lower. It may even be possible that the high for this move is in for now with regard to the EURUSD at least. The chart below shows the EURUSD with 2 day candles, note how the RSI and MACD are showing very strong Bearish Divergence, in a similar way to the early 2008 peak and late 2009 peaks. Finally I have re-posted the EURUSD chart I produced a couple of weeks ago (See lower chart), back then I hinted that price action suggested an extended consolidation is possible, this seems to fit in with a failure in the Euro in the low to mid-1.4000s and further consolidation in the the upper 1.3000s to low 1.4000s..  

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Some more on trader psychology: I was recently writing an article for someone on the characteristics and traits of successful traders. One of the major traits all successful traders have is their ability to think independently and when necessary stand back from the crowd. - I used an example from my younger trading days working at an Investment Bank in the City to emphasise this.

It occurred at the start of the 1994 bond bear market. - Bonds had soared over the previous 12 months, I was part of a trading group of 12 traders. Early in that year all the talk had been about further Federal Reserve rate cuts. - Bolstered by a strong trend, and a favourable economic scenario, all the traders loaded up on the same position (long of bonds) to take advantage of the suspected rate cut. - I had a slightly different view, I was somewhat anxious about the state of the market; furthermore our ‘Technical Analyst’ was  recommending a short position; her view was that the market was dangerously overbought and ripe for a (severe) correction,and possibly a full trend change. Most the traders were, like me, fairly young and relatively new to the game, most of them had jumped on this trade largely because the two most senior traders were on the trade. - Close to the end of pre-meeting day, I had actually wanted to go the other way, but found myself compromised, however I cut my long position and went flat.

As expected the Fed cut rates by 50 basis point that night, however after a momentary jump in bonds, the market turned around and started dropping and just continued to drop, by the end of the next day bond prices had made a serious and dramatic turn lower. Although the Fed had cut as expected, they also indicated that the economic cycle may be turning and that this could be the last rate cut. Some traders cut quickly, but most hung on in the hope that this would turn, eventually suffering heavy losses and being forced to cut.

This highlights the danger of a lack of independent thinking. Some of the younger traders learnt a harsh but valuable lesson from this, those that heeded this lesson went on to become highly successful traders.

For the record the Technical Analyst at the bank at the time was Carol Harmer. She was the best tech analyst I have had the pleasure to work with. She still provides daily technical analysis for intraday traders across a wide spectrum of markets from her base in Gibraltar. - Her link is Charmer Charts which can be seen by clicking here. - She offers potential new customers a free trial of her service, I would recommend giving her service a try.


On that note, I will bid you a good weekend. However before I go, 'Something for the Weekend' :  In honour of US equity markets- Soul Asylum and 'Runaway Train'.




Have a great weekend.

SP500 further gains and USD further weakness still on the cards.

QE is now done and dusted, the market was not disappointed, and the green light has been given for equities to rally and the USD to weaken further. On the face of it, that is how it seems, and until I see anything to tell me otherwise I think that is the way forward for now. -- I say this as someone who does not look through rose-tinted glasses and think everything is alright for now, far from it, I think dark times lay ahead. The US economy as well as most other major western economies are in a mess caused by such excessive levels of debt, that it will takes years, perhaps tens of years to work off. - The ideal would be for moderate levels of inflation to ensue for a number of years, not too hot/not too cold, but enough to raise asset values, whilst growth increases employment, and consumers, governments and municipals are able to repay debt and banks continue to repair their balance sheet. At the same time the emerging or emerged economies can continue to grow, whilst their currencies revalue over time and the world starts to re-balance.  At which point all the fairies at the bottom of my garden could hold a little party and perhaps invite Father Christmas.....

As I stated above, there seems little in the wake of the way the market has reacted to the QE announcement thus far to alter my short-term view, the SP500 has run into the consolidation zone from April this year, which may provide some resistance, but I see little else currently standing in the way of higher equities levels right now. 

GBPUSD FX still seems on course for an attempt at the 1.6700 area, as per Tuesday's analysis. The Cup and Handle pattern has held the 1.6000 line (despite a brief intraday dip below), and looks to be following the textbook behaviour of this pattern. - See chart below - The text book pattern and Tuesday analysis can be seen here. 1.6000 should now act as solid support; much below there is likely to be indicative of a failed breakout.

The weekly chart is also supportive of this move (See chart below).  Note, there is heavy resistance from a number of sources around 1.6700, if GBPUSD reaches these levels this will likely be a major battleground between further gains, and a correction all the way back to 1.6000.  

'Inner Circle' research survey on Fed QE

There is only one topic of discussion, I am not going to try and predict what happens in the minutes and hours post tonight's FOMC meeting. However I have received a good piece put together by a leading research house, it is a survey of some leading players (Inner Circle) in the treasury market and what they think may happen tonight in regard to the Fed's action and likely reaction.

** *The Survey ***

1.Q- How much do you thing the Fed will ultimately buy....?

A- The average came to $862 bn, with several respondents indicating a bias to more if conditions warranted.

2. Q-How long will they buy for....?

A-The consensus says for the next 10 months.  The devil is in the details with the focus on the next six months, about $100 bn per month, and then tapering off in H2 of 2011.

3.Q- Will the FOMC offer a degree of shock and awe, i.e. $100 bn for each month for the next several months and then review, or something more open?

A-The answers were interesting.  On the one hand, overwhelmingly people felt the statement would offer a high degree of flexibility and therefore be somewhat vague and open-ended.  This could prove a bit
disappointing and the point was made to us.  On the other hand there were several who felt the lack of shock and awe in terms of size could or would be offset by the Fed changing the language about 'extended
period' by  extending it even further or perhaps put explicit focus on a sector, i.e. the belly.

4. Q-With 10s at 2.61+%, how much is priced in (name a figure)?

A-This was tough as we got percentages, basis points, and dollar amounts.  Dollar amounts got the most responses and so with that we offer that this survey says $400 bn in priced in.

5.Q- If they buy 500 bn, how much lower can 10-yr rates go?  1 trillion?

A-The consensus came to 2.35% for $500 bn and 2.10% for $1 trillion.

6. Q-How will you position going into the meeting?

A-54% or those who responded (a majority) said long and/or in a flattener.  35% said flat.  And 11% said short or in a steepener.

7. Q-What are you expecting to do coming out of the meeting?

A-31% of the respondents said 'Wait' or 'Watch' with some saying they'd follow the action.  21% said they would buy with 18% apparently thinking the same way only they said they would buy pullbacks.  26% said they planned to sell strength.

GBPUSD (Cable) maybe be preparing for a decent move.

The GBPUSD spot fx (cable) rate has made steady gains of late and looks as though it may be gearing up for a possible breakout to the upside. What I like about this is that it also appears to have formed a pattern within a pattern, when this occurs moves can sometimes be dynamic.

The pattern within the pattern is as follows:

1) The larger pattern is the Weekly 'Descending Expanding Triangle' pattern formed over the past 15 months, which may actually be part of a big double-bottom pattern. The actual pattern bears a strong resemblance to the bullish pattern formed on the AUDUSD over the past year, which was covered in detail in the 17 Sept post which can be seen by clicking here. An illustration of the ideal formation can be seen here:

2) The secondary pattern, which has formed as part of the breakout of the above pattern is a Cup + Handle  on the daily chart. Cup + Handle patterns do not necessarily have the greatest success record with regard to pattern reliability, however what I like about them is that they offer excellent risk/reward ratios. The stop level is usually quite close to entry, whereas the upside (if the pattern is successful) is often relatively large. The following illustration highlights an idealised Cup + Handle pattern.

Put the two together, and there is potential for a decent move if this can hold over 1.6000 on a sustained basis. The chart below shows these pattern on the GBPUSD.

There are one or two reservations with this: Firstly and principally the weekly 'Descending Expanding Triangle' pattern does not follow in the wake of a large trend, the prior move is short trend which itself is a reaction off a low following a very large decline. Typically these patterns follow strong sustained trends as per the AUDUSD example. I also prefer these patterns to have largely tracked along the upper line at fairly even spacing, the GBPUSD pattern has touched (or nearly touched) the upper line on four occasions prior to breaking out, however the gap between the third and fourth was very large. -- Perhaps I am being picky, ideal patterns are very rare, however I feel these points are worthy of a mention. The Cup + Handle pattern does look textbook though, and as long as this can sustain itself over 1.6000 (allow a spike or two lower), then this favours a move to around 1.6700.


A quick note re: the SP500: Despite a strong move at the open it once again failed to maintain and hold a move higher, and it also failed to maintain an afternoon push lower, once again closing slap-bang in the middle of last weeks daily closing 1182-1186 range. - dull, dull, dull.

Have we had 'the pause that refreshes' the SP500??

The past week/two weeks has seen largely consolidative price action as the market has geared itself up for some heavy news and data releases. The main event of course is this week's FOMC with the results due this Wednesday with the likely announcement of the details of the next bout of 'Quantitative Easing'. There is also the mid-term elections, although I think this will probably have limited market impact, more importantly we have some major data including the ISMs and the key employment data.

The strong rally in equities and the large sell-off in the the USD over the past two months has been largely on expectations of further easing actions by the FED. Last week was volatile but never went anywhere, despite ranging from 1171 to 1196 the actual closing levels on all of last week's days was within a tiny 4 point range of 1182 to 1186. The question for many is whether this has merely been corrective consolidation, or part of a topping process. My favoured view at this stage is that we are still within a bull run, and that the past week or two has been part of a consolidation that may be close to running its course, or may still have further to go, particularly if the reaction to this week's news sees a 'buy the rumour, sell the fact' reaction. I do not believe we are in a topping process, though one can not rule this out, though I do think the market will eventually top-out, probably sometime next year from somewhere in the mid to upper 1200s or maybe even a touch higher. I think it will take a failure of QE2 to ignite that, and if that occurs it is unlikely to be well into next year. The main features of the SP500 currently, are a strong rising trend, however some waning of momentum which could be suggestive of a deeper or more pronounced correction still to come, and also some hesitancy now that the SP500 has entered the consolidation zone from April of this year. (See chart below). I see three potential scenarios playing out here:

• The first one sees a very favourable reaction to the QE news, and a surge through the April highs over the remainder of November.
• The second scenario, is a 'buy the rumour, sell the fact' reaction. Possibly with the 'sell the fact' coming after Friday's payroll report and the following week. This sees a deeper correction possibly to 1130/40 maybe even lower on a spike, before basing then moving back towards the recent high, before eventually making a strong bull run in early 2011.
• Scenario three, would see the 'buy the rumour, sell the fact reaction', which is part of a major top, and is the start of a much deeper sell-off back to at least the summer lows. 

Scenario 3 is in my opinion the least likely, whilst I believe scenarios 1 and 2 are probably equally likely. Scenario 2 would be very interesting as it would see some mean price action which could at first trap some bulls and then create an even bigger trap for bears....

More Market Psychology - The Roulette argument.

Whilst the market awaits the slew of data and news of the next week, trading seems to be slowing to a grind. The data releases start today with the first release of the US third quarter GDP, in light of the debate within the FOMC regarding QE, this could prove to have even greater significance than usual: At least in the minds of market participants, even though the first release will probably bear little or no resemblance to the final revision. - I am not going to get drawn on market direction today, as I think we face too many variables heading into next week.

I would instead like to comeback to my posting from last Friday on the issue of 'Trading Psychology and needing a Strategy'. As part of that post (which can be viewed here) I suggested that for many traders their flawed strategy or perhaps lack of strategy, was analogous to walking into a casino and playing roulette, a game where mathematically it is impossible to beat the house over the long-term. This actually caused quite a bit of debate with some friends and ex-colleagues who refused to accept that the house could not be beaten at roulette.

These are people who are extremely successful and highly intelligent (almost certainly more so than me) and yet they refuse to agree that the house can not be beaten. One argument that is put forward (by more than a few people) goes something like this: Assuming the payout is 35:1 and the chances of winning are 36:1 (European game), then lets say the numbers 1 and 2 both come up twice, each in four consecutive spins, then the odds of these two numbers coming up again is highly unlikely, thus the odds are now closer to 34:1 whilst the payout is still 35:1, thus shifting the odds in the favour of the player over the casino. This is a common misconception, even if in the example given, the number '1' came up for four times in a row, there is still as much chance of the ball dropping on the number '1' as any other number on the next spin. They also tend to quote examples of times when this has occurred to them, as proof of their argument.

The argument proposed here panders to one our own human biases. As humans we all like to think we are rational, however we are in fact often far from rational, for example if we own something we tend to believe it has more value or worth than if we do not own it. – It is these common biases and misconceptions in peoples thinking which drive markets and lead to traders making basic mistakes. By the way if we all did think rationally then the game of roulette would not exist nor most probably would markets, but life would also be a damn-sight less colourful. – I will cover biases another time in more detail, as understanding them is necessary in understanding markets and ourselves.



I am keeping today's posting brief, partly because I have am a touch jaded after one Guinness too many last night...




Before I go: - Something for the weekend. --- Something mellow in fact --- One of my favourite bands of all time singing one of my favourite songs of all time. The Kinks - Waterloo Sunset.









 

Likely to remain volatile into next week. + US 10 Year + Is Greece hotting up again?

The US equity markets continues to behave in a volatile nature, this is not surprising given the weight of news and data over the next week. A QE story seems to hit the wires about every 5 minutes, it appears that opinion remains strongly divided both within the Fed and outside. My call is that Bernanke, being the sly old fox, will pander to both sides, perhaps not doing as much as the most extreme expectations, but none the less providing a strong boost, but within that also allowing flexibility for the future so that of he needs to hit it heavy and hard he can, or if he needs to ease back he can. - I do not expect the issue to actually be resolved fully next week, thus this will likely remain an on-going theme for the next several months, adding to increasingly volatile markets. I do not think much, direction wise, will be resolved until next week at least, but clearly the news will have the ability to slice a chunk off of the market, or give it an extra boost, which is why we are seeing increasingly volatile short-term action.

Moving on to US 10 Year yields. This is obviously a central theme in the on-going QE debate, since these are likely to be one of the main tools used by the Fed in the QE operations. However, an awful lot has been priced in on these, and in the past few weeks some of the froth has started to disappear from the 10 year t-note futures markets: Yields have seen a decent pick-up, rallying almost 40bps from the low 2.30s to the low 2.70s yesterday. I had been expecting this to move lower towards 2.00%, however whilst I do not rule this out for a later trade, short-term it looks like a low is in, and the risk of a rally towards the low 3 handles is a real possibility in the next few months. The first chart below shows US yields over the past couple of years.

The chart above shows how the yield has been forming a 'Falling Wedge' pattern in recent months, whilst momentum as measured by the 10 day RSI has been diverging upwards. The past couple of days has seen a breakout from the wedge, the yield may comeback to re-test the top of the wedge, but the risk is that it holds and moves higher. - The 10 Year t-note continuation future chart is also supporting these assertions. The top chart below shows this on a weekly basis. A couple of observations which I have highlighted:

• Firstly the strong similarity between the recent price and momentum action and the price and momentum action at the interim top in early 2008, both highlighted within the mauve ellipses. Note the sharp correction led to an extended consolidation, after which the main rally re-asserted itself. 

• Secondly the similarity between the bigger picture price action and the next chart below which shows Gold weekly 2006 - 2010, in particular the price behaviour as highlighted by the large red ellipses on both charts. On both occasions the breakout of these large patterns led to strong dynamic rallies. In the case of the Gold the rally eventually led to the Gold price being well overbought in late 2009. This saw a sharp correction followed by consolidation, eventually however the rally in Gold, as we know re-asserted itself.

The market is likely to see some rebound I think before and possibly around next week's news, however the move to higher yields could be a theme in the next few weeks.  Will this affect stocks? I am not sure, historically these markets move inversely, however the relationship between these two has not been consistent in recent years. However, if stocks were to suffer a sharp drop, then it is likely that bonds rally and yields drop, thus if the above scenario above were to occur, it is likely it would happen against a steady or rallying stock market environment.

Finally with regard to Greece; there has been a lot of negative talk hitting the wires these past couple of days. One theme seems to be how, with economic conditions weaker than expected (not helped by the EURUSD recovery), tax revenue is coming up short of projections in parts of Europe, and as a result countries struggling with high deficits are now confronting the prospect that they will miss the budget deficit targets forced upon them this year. In the past couple of days things have started to stir in Greece whilst Ireland has had mounting issues in the past couple of weeks. The charts below show the 5 Year CDS for Greece and Ireland over the past 6 months, below that is a chart of the SP500 Index and the EURUSD. I have highlighted the two prior occasions when the 5 year CDS prices moved up sharply in the past 6 months, and how this saw sharp drops in the SP500 and the value of the EURUSD. In addition I have placed emphasis on the action of the past week. - If this whole Euro Sovereign Debt issue were to explode again, then the above analysis is likely to be wrong on the T-note, as US yields should drop as a safe-haven bet while equities would once again probably turn ugly. 

 

SP500 observation and USDJPY update.

The SP500 rally seems to have run out of steam for now. I think this is a corrective pause which could retrace further, I am thinking perhaps a dip to the low to mid 1160s on the e-minis, with perhaps an extension into the mid 1150s. I had expected some volatility and corrective price action ahead of the slew of news/data of the next couple of weeks, however I think the bigger bullish forces underlie this market for now and these should keep this from dropping too far.  I also want to highlight a similarity between the current 'Price action and momentum' set-up, and the set-up in April/May 2007 (See chart below - Click chart to enlarge).

The next two charts below show close-up views of these two highlighted areas.

Note the strong similarity between the two set-ups, this does not of course guarantee we will see subsequent price action of a similar nature, however I do believe that price action of a similar nature may be a strong possibility.

USDJPY FX

The USDJPY put in its first decent correction in some time yesterday, this came after Monday's closing level was within a whisker of the historic low closed on the USDJPY. Looking at the weekly USDJPY chart (See below) this week's low (so far) has occurred right on a major support level going back almost 10 years. I intend to look a little more closely at this in the next couples of days.

Finally in reference to yesterday's posting on the EURJPY; the follow through on the 6 hourly candles 'Three Black Crows' was weak, however the upside has also remained in check thus far.

EURJPY FX

With markets likely to track time this week ahead of next week's slew of news. It is an opportunity to look at some other areas of interest within the wider markets. Today I will look at the EURJPY FX cross, as there may some interesting action occurring here.

The first chart is the multi-year weekly chart. Currently the major trend remains lower, however momentum is strongly divergent here; momentum as measured by the RSI and MACD on the recent 2010 low is well above the momentum levels recorded at the low of 2009. This does not mean a break-up through the declining trend-line or a trend change is due, direction is primary and momentum is secondary, however it is suggesting it is a reasonable possibility. In addition I want to emphasise the strong similarity between the price action and momentum developments over the past 2/3 years, and the period in the mid-1990s when this currency pair made a major low.

 
The weekly charts thus appears to offer some interesting possibilities. The daily chart below can add some further clues, though nothing decisive at this stage. The first thing to notice is the large Expanding/Broadening Triangle formed over the past five months. (See notes and illustration below regarding Broadening Formations - btw the example described refers to a broadening top but it is also valid as a broadening bottom, particularly in currencies where we are comparing two currencies, rather than an asset.)

 
John J.Murphy in his book 'Technical Analysis of the Financial Markets' (in my opinion - the Bible of Technical Analysis) shows a diagram of an idealised Broadening Formation. (See image above).Murphy goes on to say - "This situation represents a market that is out of control and unusually emotional. Because the pattern also represents an unusual amount of public participation, it most often occurs at major market tops (Bottoms). The expanding pattern, therefore, is usually a bearish(bullish) formation" . With regard to volume during the formation of the pattern Murphy says -“The volume pattern also differs in this formation.  In other triangular patterns, volume tends to diminish as the price swings tend to grow narrower.  Just the opposite happens in the broadening formation.  The volume tends to expand with the wider price swings.”

Coming back to the EURJPY we thus have a weekly set-up where the downside is still in charge, but strong corrective influences are at work. And a daily chart showing a strong reversal pattern, however within this pattern is still the possibility of one more dip lower, and/or the possibility, as with all patterns, that the patterns does not actually work. I would also like to add that the price is pushing against the downtrend, which adds some tension to the situation, a continued rejection of the downtrend would favour the dip lower scenario, whilst a sustained break of the downtrend, would be a signal that further strong gains may be in the pipeline.

Finally, the short-term chart also has an interesting little pattern. I show this on the 6-hour candle chart below. The pattern is a Sideways/Declining 'Expanding Wedge' , these can produce quite explosive upside moves. I do have some reservations about this particular example though; the slope of the upper line is more pronounced than I like to see in these patterns, typically I like the upper line to be close to horizontal or at least a gentle downward slope, however the proximity of the major downtrend line may be influencing this. I would also like to add that the trading signal to go long on a break of this pattern would be a move over 113.94 the last high in this pattern (however, it is worth bearing in mind that the major downtrend line intersects aroind 114.50), with a stop placed dependent on other factors. I would not suggest going long unless 113.94/114.00 occurs, particularly as very short-term, yesterday's price action produced a bearish '3 Black Crows' pattern, which may produce downside follow though in the next couple of days.

One final thing with regard to this trade. A look back at the weekly chart suggests to me that if the down-trend line is broken, then the upside potential could be very large and relatively rapid. This suggests to me a very good risk/reward trade. If the break-up were to occur without the low of the past 24 hours being broken, then we are talking about a long instigated at 114 with a stop at 112.40, and potential upside target of 140.00. The risk would be 160 points, the potential reward 2600 points = Risk reward ratio 16.25:1. And no carry cost.

Strong gains this morning, but I think further volitility nay ensue.

Markets have soared this morning, the catalysts appear to be a rather benign response at the G20 to USD weakness, plus a Goldman's article suggesting QE2 may be much larger than some think. Despite this early rally, I can't help thinking we are likely to see some more volatile and messy action this week, we have a heavy data week this week, then next week we face a landslide of major events, including US Mid-Terms, the FOMC meeting plus the QE2 announcement, and as a side show more economic data including the US payrolls.

With so much facing the markets, despite this morning's strong move, the remainder of the week could be volatile. This should continue to provide short-term trading opportunities for scalpers and intraday traders, as per last week. - Bigger picture the major trend on the SP500 since early September remains on track, however momentum is showing some signs of waning and turning a touch, though at this stage this is secondary to the bigger trend.

The chart below shows the EURUSD, I have highlighted some price action which I believe suggests, that we may see an extended period of consolidation in the EURUSD, even though short-term further gains are possibly likely in the wake of this morning's news.With the rallies in the EURUSD and the SP500 since early September having been pretty well co-ordinated, any consolidation/corrective EURUSD activity could see a similar price action in the SP500 .

My old risk barometer AUDJPY still gives me cause for concern on risk. Whilst this is not a clear signal, it is another factor to keep an eye on (See chart below). Essentially the rally in the SP500 has not been supported by the AUDJPY since mid-Sept. Whilst this is no doubt down to expectations of QE2, this has a strong correlation going back to 2003, see my article on this posted last week, (Can be seen by clicking here).

Overall a strong up day on stocks and weak USD will likely be the theme for the day, however I think markets will remain cautious and patchy this week, I do not think we will see clarity until at least the early November events are out of the way.

Uncertainty across markets. + Trading Psychology: Needing a strategy + Ali.

Markets have been highly volatile this week. The SP500 has had a 30 point range centred around 1175, the EURUSD has ranged from 1.3700 to 1.4050; wide ranges and no direction are prevalent across many markets this week. The upcoming G20 meeting this weekend, the more crucial Nov FOMC, where all should be revealed regarding further Fed action, and the backdrop of major industrial action and violence in France are all serving to make conditions extremely uncertain. I will not dwell on markets any further for now as I think it is best to stay out for now and see how things pan out. Instead I would like to talk about Trading Psychology.

A couple of weeks ago I blogged an article titled 'Mastering psychological and emotional aspects is critical in trading'. Today's post will look at why a defined strategy and careful application of that strategy is so vital to gaining an edge and be successful.

I am going to use a couple of analogies to help illustrate the point: Think of a trader's approach to the markets as a person walking into a casino (the analogy is not being stretched that far). The casino has two tables, one offering roulette, and one offering blackjack, the trader does not make a conscious decision to go to a table, however he makes a subconscious decision. Lets say half the traders move to the roulette table and other half the blackjack table.

Roulette :  A game that it is impossible to win in a casino if continually played: The odds of winning when the ball drops on a single number are 37:1; the payout is 35:1. In fact whichever strategy one chooses; red or black, odd or even, etc, the payout is always marginally lower than the odds of winning.

So why do people play it ? Well a win of 35 times the stake sound very nice, when not weighed against the risk. It makes people feel good; furthermore people fool themselves into thinking they are actually very good at this, or that they have some sort of control over it, in other words it satiates their egos. Another explanation is that people are not actually tracking their losses and gains, over time they will forget or ignore their losses and focus only on the times they won, and when they do lose they are usually convinced that they will win next time. In addition many of them will be satisfied since they enjoyed the buzz of being around the roulette table and in the frenetic exciting world of the casino. There is even a certain machismo chest-thumping pride amongst some people when they lose big. – however and whatever the circumstances, in the long run continual playing of roulette provides guaranteed losses for players.

Now consider Blackjack. – The odds of winning in Blackjack are also stacked against the player. It is hard to define the true odds of winning on Blackjack; there are so many permutations both within a standard game and given the number of rule variations, however the odds are slightly tipped in favour of the house. But there are ways; lets call them strategies, whereby the player can tip the odds ever so slightly in his favour. It is known as card counting; it is not an easy thing to do, not easy at all, however with practice, plus discipline and patience, it can be done. Thus if done well; a player can successfully tip the odds slightly in their favour, giving them that crucial ‘edge’. This is the game that the many traders, including the successful ones try and play; in reality only very few are actually able to carry off the art of card counting, however those that are able to succeed at it will be the winners, it is they who equate to the 5 - 10% of people who enter trading who are able to make a success of it.

 (For a really good read on blackjack and card-counting I highly recommend 'Bringing Down the House: The Inside Story of Six MIT Students Who Took Vegas for Millions' by Ben Mezrich , which I referred to previously in my earlier piece 'My top 10 Trading related books'.

Before, I leave this I want to show one further example of how strategy, and correct implementation of that strategy, can turn the odds in ones favour. The example is from the world of sport, and probably the most famous boxing match of all time; 'The Rumble in the Jungle' between Muhammed Ali and George Foreman in Zaire 1974. I was ten at the time and remember it well as it was all anyone was talking about. The question at the time was not if Foreman would beat Ali, but in what round.

Ali was 32-years old and considered to be past his prime. He had lost 2 of his past 14 fights, these were against Joe Frazier and Ken Norton, though he ultimately beat them both in rematches. Meanwhile the 24-year old George Foreman was at the top of his game, having knocked out both Frazier and Norton, each in two rounds. Foreman was considered an awesome, dangerous boxer his record was 40 wins in 40 fights, and even now his punch is considered the greatest punch in boxing history by many.  He was considered unstoppable by most commentators and experts at the time.

However, Ali had a strategy, the strategy was clearly thought out and practiced in training, it also involved pre-fight strategy implementation, including the following steps:-

Ali charmed the people of Zaire in the build-up to the fight, thus ensuring that as he entered the ring it would appear to be as if he was fighting on home ground.

In preparation for the fight Ali's training was honed almost to perfection. One particular story highlights this: After every sparring session Ali would ask the guys he sparred with how they thought he was doing, the sparring partners would be courteous to Ali, telling him that he was fast and powerful and that he would overcome Foreman. However after one session with a new partner Ali asked him the same question, he replied 'Foremans going to flatten you!, hes too big and too strong, you're just not powerful enough to defeat him'. Whilst there was an outcry from Ali's coaches and trainers, ordering them to get this man out the room, Ali told everyone to be quiet and said 'double his salary, he stays until he tells me how I'm going to beat George'. 


Psychologically he taunted Foreman both before the fight and during the fight, he also played a feint coming flying out of his corner at the start of the fight and launching into Foreman with a string of punches, suggesting to Foreman that this would be Ali's strategy, a strategy which would have played right into Foreman's hands. Foreman had already heard that Ali was planning to fight from the ropes and try and absorb his punches, but this totally threw him.

In the actual fight itself Ali implemented a strategy he termed 'Rope-a-dope'. After the first round assault Foreman came out of his corner in the second round expecting a toe-to-toe battle. Instead, Ali leaned back against the ropes and let Foreman flail away at him. The taunting of Foreman continued, this encouraged Foreman to come at him, Ali however would lean back, only protecting his face. This made Foreman angry and later frustrated, as he gave his best shots to Ali's midsection. But the give in the ropes was sufficient to reduce the damage (It was rumoured that Ali's manager had loosened the ropes, though this was never proved). When Foreman did throw a punch at his face, Ali was able to lean back or move his head just enough that the blow missed or had little impact. This was a special skill Ali had through most of his career. He would often hit an opponent while pulling back to avoid a counter-punch. At one point in the fourth round as Ali was leaning back, Foreman pummelled him with a massive left hook into the side, the punch took so much energy that it actually drained Foreman more than it did damage to Ali.  Although Ali primarily used the rope-a-dope technique, he occasionally counter-attacked with fast, crisp blows to Foreman's face. Then he would slip back into the defensive mode. In this way, he was controlling the pace of the fight, according to his liking.

By the seventh round, Foreman had essentially punched himself out. His arms were tired and sometimes hanging on his side. Ali then used his speed and energy to do damage to Foreman, who was just trying to get in one good punch for a knockout. Ali taunted Foreman by saying, "George, it that all you've got?" Foreman realized that it was all he had.

In the eighth round, Muhammad Ali knocked out George Foreman to regain the World Heavyweight Championship. This was a complete shock, no one had seen this coming, but Ali had shown how a carefully thought out and implemented strategy could shift odds, even when everything seems so heavily stacked against you. As for Foreman, he was so devastated by the defeat, that he was never again the same fighter. (Though years later he did produce a mean grilling machine!!!!).




The point of all this is to emphasise the importance of a well thought out and implemented strategy. If one wants to be successful in trading they need a strategy like a blackjack card-counter in the casino, if they want that strategy to be successful they need to implement it with planning, precision, discipline and self-awareness, in the same way Ali implemented his strategy versus Foreman.


On that note, something for the weekend : It could only ever be one thing really, the eighth round from the 'Rumble in the Jungle', as my personal ultimate sporting hero Ali defeats Foreman. I suggest this is played with the volume up as the commentary is superb.



I also suggest you also watch this superb you tube clip from a serious of famous interviews from the 1970s between British TV interviewer Michael Parkinson and Muhammed Ali:  It defines the man perfectly.





Have a great weekend.

Poor correction attempt on SP500 should help the bullish cause. + EURUSD update.

I had what historically was a very bearish 2 day-candle pattern on the SP500 over Monday and Tuesday which I highlighted in yesterday's post.. However this failed to follow through and was totally annulled with yesterday's rally. This suggests to me that the market is not ready yet for a correction, and that the bulls and buy-dip traders continue to hold the upper hand over the bears and sell-rally traders; thus favouring further upside for now.

EURUSD FX

EURUSD has rebounded nicely over the past 24 hours, and I see at least a re-attempt at last weeks high at 1.4140. I am looking at two short-term patterns driving this right now. The first chart below shows a Failed Head + Shoulder pattern, it was probably always doubtful that this was a valid Head + Shoulder pattern given the weakness of the Right Shoulder relative to the Left Shoulder. Failed H+S patterns often return to the top of the head as a minimum. The second chart shows a Falling Wedge pattern, I have previously discussed Falling Wedges and have identified four different types of Falling Wedge patterns (See illustration below). The current Falling Wedge confirms ideally to a Type 1 'Falling Wedge', suggesting strong short-term bullish potential. -  Of course bigger picture considerations take precedent over the shorter-term patterns, and the high of last weeks two bearish candles at1.4122 and 1.4158 will act as strong overhead resistance. However, a clear break over this resistance should favour a move in accordance with my my views expressed last week in this post here. --- One final point, the G20 finance ministers and central bank governors meet this weekend, I would be surprised to see last weeks highs taken out ahead of this event, and the potential for further volatility remain highs particularly as this could see some feisty headlines. 

 

SP500 produces a very rare bearish candle pattern.

 Afternoon Update.

SP500 is currently trading back up at 1177 in the wake of a Medley report which suggests that QE2 will be 'very material' as it expects FOMC to vote in Nov to buy $500b Treasuries over 3-6 months but  to give an open-ended commitment to buy more over the following 12-18 mos depending on economic conditions. The report reportedly says that QE2 in this way could be bigger than the market expects and last longer.

With a lack of follow through on the downside, It would appear the signal discussed below may be invalid. Tonight's close should be watched closely, a close above yesterday's high could be very bullish. Quick note on the EURUSD this may be forming a Failed Head + Shoulder breakout, which suggests we could revisit 1.4100 pretty quickly. 
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Early morning post

The price action on the SP500 has produced a very rare bearish pattern known as a 'Separating Lines'. This sees a strong light-bodied candle on day 1, and a strong dark-bodied candle on day 2, both opening at or very close to the same level. The chart below shows this, with an illustration and description of the 'Separating Pattern' below that.

 

As I have said these are very rare patterns, and typically there is further bearish follow through. As with all patterns there are no guarantees, and any sustained move over the open/high of yesterday may suggests a pattern failure, this of course makes this a relatively cheap risk/reward shorting opportunity. 

Further to this, I have looked back over the period since 2000 to see how often these patterns have appeared. I have included 'Kicking' patterns too, as these are the bigger brother of 'Separating Lines', the main difference is that 'Kicking' patterns have a gap between the two days opening levels. There have only been two prior examples of these types of formations since 2000, occurring in 2000 and 2001. I have shown zoomed-in charts of both of these below (with an illustration of a 'Kicking' pattern.

 

Just to provide some balance, I would like to point out that the SP500 futures have remained within their rising short-term trend channel. I have highlighted this on the the chart below, which shows the SP500 e-minis on a 4-hourly basis. Though the accelerated move in the wake of the NFP number has been broken, the main channel is still intact. However any sustained break of yesterday's lows would support the view that a bigger bearish correction may be on the cards.   

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