“Stocks Take the Stairs Up and Elevator Down” – Old investing quote
The recent “tit-for-tat” tariff game being played between the US and China has brought some nervousness to the markets. In this article we’re not going to analyze the current situation, but rather use the market’s reaction as an excuse to shed some light on the differences between trading when market sentiment is benign, and trading when sentiment is skewed to the downside and the markets get nervous for whatever reason.
The old adage goes “the markets use the stairs to go up, but they come down with the elevator”. Trading bull & bear markets does have some differences, some of which we will cover in today’s article.
The chart above illustrates the point: the markets can fall violently, but take much more time to recover.
Following Market Sentiment
In the markets, it really does not matter what the underlying truth might be. It’s a fact that markets move based upon anticipation and typically reverse with the news. Markets are never efficient for they will respond to what people believe even if that belief is clearly not true. This has given rise to the maxim “sell the rumor, then buy the fact”.
The day to day and week to week oscillations really have nothing to do with facts or instrinsic value. The value of an asset changes over longer periods of time. So, what are we really trading, if we have a short or medium term objective?
Participants are very aware of local drivers, headline events, risk-factors…and when market participants get surprized – or caught with their pants down – big moves can happen even if we are far away from “value”.
My belief is that being a pure technical trader is like fighting with one arm tied behind your back. By only following the technicals, you’re never going to know what hit you. You’ll just know that you got hit. A better approach is to stay in touch with global developments, via newswraps or a live squawk service. The reason for paying attention to local drivers and influences is to know what is happening, and what price is being driven by.
Remember that one thing that hasn’t changed in all these years: people love fast markets. Many retail traders are attracted to trading because of the thrill that fast markets can give them. Unfortunately this means that they show up to do business at the worst of times (during Non-Farm Payrolls, during Central Bank announcements, etc) and are usually chopped up. Most fast markets happen to the downside and can be traded if you have a disciplined method for doing so. Otherwise, it’s like playing the lottery.
The Smell of Fear
“All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical formations and patterns recur on a constant basis.” – Jesse Livermore
The first thing that happens, when a shift in sentiment is hitting the market, is a sudden “relatively large” move against the day’s natural evolution. If the day was positive, suddenly it turns negative with a volatility expansion.
The first thing to do, when you notice this behaviour, is to check what kind of tape-bomb hit the wires and is causing this type of an emotional response. Only with this kind of confirmation can you possibly plan a logical trade. In the chart above, it was in fact dovish commentary during an ECB rate decision.
Dovish commentary doesn’t always generate this kind of a move. However, in the week before the announcement, some ECB speakers had turned hawkish and offered some forward guidance, speaking about tapering QE (reducing stimulus) earlier than expected. The Euro was trading with a positive tone into the meeting thanks to this. So the dovish nature of the event forced a broad re-shuffling of positions and the ensuing violent drop.
The second thing to do is use mini consolidations or pullbacks to get in. When the markets are moving fast, it makes sense to dial into the faster timeframes because – especially with temporary drivers or tape-bombs – the move can exhaust itself before you get a chance to trade it.
Over to You
“If you fail to prepare, then prepare to fail.” – Benjamin Franklin
We have already talked about market sentiment and how to stay in touch with it. It really adds confidence when you can understand what is driving a certain move, because you can evaluate the probability of followthrough on the move – i.e. whether it can be dealt with aggressively or not.
But in general, the market does tend to rise slowly and fall very quickly. Commodities (and cryptocurrencies) are a bit of an exception as they have explosive volatility on each side. Once again, this volatility can be beneficial if you are following the drivers and attempt to stay on the right side of the move.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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