Catch a Falling Knife

Posted March 8, 2015 By Phil Elrod

FOREX markets generally are not extremely volatile. They tend to trade with the prevailing trend for extended times and the oscillations in price are generally not very large. However, the usual oscillations, particularly for a short term trader, are often tradable and a savvy trader can make a very nice return on a consistent basis.

But once in a great while we see an uncommonly large move. If you are not already in the trade in the direction of the move getting in after it starts is a bit like trying to catch a falling knife – exciting – but very dangerous.

If a trader is very alert and extremely quick to act, a large profit can be made by entering a trade in the direction the knife is falling. The trade is not without risks because the volatility can be significant; so many traders (like me) simply sit and wait for the big move to run its course.

On rare occasions, a fundamental event sparks a violent and rapid short term move and the psychology of the market is drastically affected. The net result of this is that large moves almost always go too far before reversing. In Texas we call it a stampede.

What we wait for is the usual large bounce when the move has run its course. Those very large moves are almost always overdone. It is the psychology of the crowd. It can be much like a stampede of cattle – rushing in one direction, then reversing and rushing in the opposite direction – and, yes, reversing again in the original stampede direction. It seems to happen that way more often than not.

A savvy trader who is not already in the market in the direction of the stampede is likely watching for the bottom of that move. The initial bounce is often considerable and can present a trading opportunity. In addition the move following the first bounce is often significant in the direction of the stampede. These moves very often provide opportunities for very profitable trades. But that potential for greater profit adds greater risk. The trader must be skilled, alert and act swiftly. These trades often happen quickly. This type of trading is like catching a falling knife; it must be done with skill and caution or you can hurt yourself.

The FOREX markets have experienced two such events in the last ten days. Let’s look at these events and see if a trader with the nerve and expertise could have made some profit here.

Figure 1 EURCHF January 15 4000 ticks per bar.

The Swiss Central bank had pegged the Swiss Franc to the Euro at a rate of 1.2000 Francs to the euro for more than two years – and it had defended that position vigorously.

Then suddenly, on the 15th of January, the peg was dropped and the Swiss Franc made a move up against the euro. The EURCHF pair took a nose dive to the downside. The size of that move was of epic proportion and happened in a matter of minutes.

The chart shown in Figure 1 shows the EURCHF pair and that dramatic move after the 1.20 peg was dropped. We have added three white horizontal lines to emphasize the following analysis points.

The violent move downward eventually bottomed out at about 1.0200; that is a whopping 18 big points. A great many millions (probably billions) of euros were lost in a mere 13 minutes by those who were long the EURCHF pair.

Anyone that was short the pair made a lot of money in a mere minutes. We were not short the EURCHF at the time the move started, so we did not get rich on the move.

But we were watching for the next best thing: the bouncing that almost always happens at the bottom.

Note that very near 1.0200 the price suddenly started a reversal pattern and went all the way back up to a bit over 1.0600. That is a move of about 4 big points, Capturing just half of that initial bounce would have earned a trader 100% profit – and the trade would have taken less than an hour.

And the move down following that initial bounce upward was even larger. The price then moved from just over 1.06 all the way down just under .980 – a move of more than 6 big points. A trade capturing only 50% of that move would have earned the traded a nice 150% – but it could have meant holding the position for several hours.

Over the span of the next few days, there were additional moves of at least 4 big points – half of which again means a profit of 100%. I never met a trader who would not get excited about trades that earn 100% profit. Such profits are epic when it takes a year to happen. When it happens in the domain of a few hours it is truly legendary.

Okay, from hindsight we just made a lot of money. But were there signals that we could used to enter those trades in real time.

Yes, but not from the chart in Figure 1. We have to look at other time frames.

Figure 2 EURCHF January 15 800 ticks per bar.

The chart shown in Figure 2 was constructed with ticks per bar changed from 4000 to 800. We also had to adjust the display to start plotting after the massive drop included in the previous bar so that we can easier see the amplitude of subsequent moves. Also note that the scale is such that the top and bottom white horizontal lines are not visible: they are essentially the top and bottom of the chart.

The bounce up and the two subsequent bounces; one going down and then another going up, are evident in this chart. But can we actually see how a trade might be made; remembering that real time trading means we only see the pattern that exists at that moment, so our logic must be based only on what we can see at the point of entry.

The initial trade would have been constructed using price bar patterns alone. The primary reason for this is that all indicators used in technical analysis are based on past data and that monster move caused a distortion in most indicators to the point as to render them temporarily unreliable. Thankfully, we spent some time on price bar patterns as part of our early learning curve.

We want to construct such trades in a manner that is as conservative as possible due to the market volatility and the momentum with which it is moving.

To make it easier to follow the logic I have placed three arrows on the above chart that are the focal points of the logic of the indicated trade; from the green horizontal line up to the purple horizontal line.

The logic for the trade is as follows:

First, I want to see a reversal that is at least as large as the amplitude of the longest price bar I see to the left of my potential entry point; represented by the yellow arrow.

This occurs at the green arrow, so I am willing to enter this market as quickly as I can after price has broken out above the green horizontal line. My exit stop would be placed just below the green line.

Staying in this trade would make sense until price had peaked and returned to the purple arrow. At that point price has peaked, tried to reverse and rise further, but failed; then it had broken the previous low price.

Such a trade would have netted at least two big points (a 100% profit), with an acceptable level of risk (about 5 to 6 times the risk).

A reversal of the position (selling long and going short) would have been a reasonable trade at the purple line as well as simply selling.

Unfortunately, I was not actually trading on that fateful Thursday and Friday, but I can assure you that I would have taken those trades as my actual trading chart includes other indicators that would have not only confirmed the logic of the trade exit, but would have given me signals that could have significantly increased the percentage of the move captured by the trade by getting out much earlier.

My normal trading system chart is shown in Figure 3. Note that this chart is set to only 160 ticks per bar.

When I trade FOREX I use three intra-day charts. The longer intra-day chart is for watching for trading opportunities, the middle intraday chart is for actually constructing the trade and the fastest of the intraday charts for making the entry and exit trades. Viewing these charts simultaneously gives me a more accurate picture of what the market is doing and what it may do next.

Figure 3 EURCHF 1-15 160 ticks per bar.

I usually have the Bollinger Bands on my trading chart, but disabled them on the chart shown in Figure 3 because they were blown apart by the colossal downward move and reduced the price bar lengths too much.

My version of the MACD is at the top of the chart and my version of the Stochastic Oscillator System is just below. Also plotted over the price bars is my proprietary indicator the RMI (Relative Momentum Indicator).

In addition, the cyan (Blue) line near the bottom of the chart is a support/resistance line generated by my trading method. It would have been there prior to the event occurrence. That line became an area of resistance after being penetrated to the downside.

I cannot honestly say that I would have entered the trade sooner than indicated by the green arrow, but I can absolutely say with confidence that I would have exited (most probably a position reversal trade) long before price retreated back to the purple arrow. My system was screaming sell at the very top of this move, a full big point above the purple arrow sell signal.

The euro had a bad hair against the US dollar that Thursday and Friday as well. However the real haircut for the EURUSD pair came the following Thursday and Friday, and is still happening live as I type.

Figure 4 EURUSD 1-23-15 7500 ticks per bar.

The ECB announced their version of QE (Quantitative Easing in central bank lingo, Queer Economics by my more limited vocabulary) and the market immediately hauled the Euro to the woodshed and began beating the hell out of it.

Once again, I was not short the EURUSD pair and missed the really big move down. But I was able to pounce on the bounce in the early morning.

The chart shown in Figure 4 shows the trade entry as a green up arrow and the trade exit as a purple down arrow. I have also added vertical lines to make it easier for you to see the relative state of my indicators at entry and exit.

The chart includes three cyan blue) lines that my trading system had placed on the chart at the beginning of the week. It is worth noting that the trade took place between two of these lines, hence my method is named “Trading between the lines.”

The purple horizontal line just happened to fall almost exactly on the top of my topmost cyan line.

The EURUSD pair was trading at near the 1.1600 level early Thursday, by the following Friday morning it was bouncing off the 1.1100 area. That is a whopping 5 big points in two days. And little more than a month ago it was at 1.2500. That is a lot of movement in a very short time.

There are those predicting parity between the euro and the dollar and it may happen, but the movement in the past month is not going to be repeated any time soon. The comparison of the euro to the dollar is not a beauty contest; it is a least-ugly contest. And from where I sit, Prince Charming would hate to be seen dancing with either of those girls at the ball.

I was able to get in a trade on the bounce, but by the time I was up and at my desk the move had already started so I had to settle for less than if I have been in at the initial stage of the bounce. Also I needed my full set of trading tools for making that trade, as the price bar patterns were not nearly as clear as with the EURCHF move.

Never the less we bagged a trade of more than a full point. Don’t get many of those as a very short term trader (meaning I do not hold positions overnight (well, not very often – and always with a stop in place).

I suppose the big lesson here is that you do not have to catch the falling knife to make a nice profit when markets make huge moves. Just wait for the inevitable bounce. Just always remember the physics of the game: price must stop moving in one direction before it can go in the opposite direction. The thing is that change can be difficult to determine, so only try the trade if you have a system that you feel confident about its ability to find those bottoms – and always be prepared to exit quickly if you misjudge.

Fortunately, I am a very short term trader and I do not have to love the markets I trade. If I had to like a market before trading it, I would probably just have to find another line of work. The markets I trade have always been a bit fickle, but lately that adjective is not enough; schizoid however does come to mind.

I love traders, trading and market analysis, I really do. And I am not usually so pessimistic, but the negative vibrations have been really rattling my cage lately. And that was before the events of the last two weeks!

The central bankers of the world are smoking stuff that the rest of us don’t have access to.

Trade, but do so with caution. These are strange times we live in.

Good luck in your trading.

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A New Year – New Trading Opportunities

Posted January 10, 2015 By Phil Elrod

I haven’t posted anything in a while beaseu I usually do not trade much during the holiday season – from Thanksgiving until after the new year. The reason is volume drops off on so many of the markets that I love to trade. Low volume makes the markets harder to trade because the spreads can get larger and the volatility can be greater.

I have been unusually slow to get started this year. Could be I am just getting old and tired, but the real reason is that I am an anomaly. I am a macro thinker but a short term trader. Sometimes that presents problems because the macro picture is so out of whack in many markets. I have been trying to reconcile in my mind what the hell is going to happen next. The stock market has been going up, in my opinion, on dreams of prosperity, while prosperity itself seems to be always just beyond reach.

Statistics are so massaged and manipulated these days that I don’t trust them very much. My general feeling is that things are not really all that great. Not especially bad, just not all that great. The FED is printing money at an alarming rate. They say, whoever they are, that it will not cause a problem in the future. But common sense suggests otherwise. The mountain of debt being piled up all over the world will surely have consequences – serious consequences.

However, none of it makes a damn to a trader like me if they (make that me) simply follows the rules of short term trading. So I am going to get in front of the mirror and lecture the hell out of myself. Then get my lazy ass to work.

It is just always in the back of my mind that my kids and grandkids are going to be the ones to truly pay the price for the financial irresponsibility of our generation. All debt comes due sooner or later – and there will be consequences.

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Hypoxia

Posted November 22, 2014 By Phil Elrod

Hypoxia is a danger to airmen. The condition is known to all pilots, even the private pilots, such as me, and others who fly small airplanes. Hypoxia is a condition caused by oxygen depletion. Flying a small airplane to extreme levels can cause the level of oxygen in the air to get to a dangerously low level.

It has been said that Hypoxia can happen so slowly that one does not even notice it; until it is too late. Studies have shown that one of the symptoms of hypoxia is a feeling of light headedness, actually to the point of euphoria. If that is true, I have always wondered why those people who decide to take their own life didn’t try to arrange to do it by inducing hypoxia. There are, in my opinion, no good ways to die. But there are certainly some ways that are better than others. Surely a feeling of euphoria at the end has to be one of those better ways.

So what the hell does hypoxia have to do with trading securities? As a short term trader I don’t think too much about the long term trends in the market when actually making a trade. But I do watch the markets long term trends in general. When markets get \to extreme values, even the short term trader can take advantage of that because the moves in the opposite direction when the market reverses can be quite large and profitable.

Hypoxia for a pilot is a result of flying too high without adequate supplemental oxygen. The current stock market is beginning to look like a pilot that is flying a little too high with a questionable oxygen supply. The oxygen supply for this market, in my opinion has been primarily provided by the FED and their money printing policies. The underlying economics of our markets are not very encouraging. There is a limit to what the FED can do; and a limit to how long they can keep it up.

There is a limit to how high a pilot can fly a non-jet aircraft without turbo charging the engine. This market, to me is like a piston engine aircraft and the FED is the turbo-charger. Even with turbo-charging, a piston engine aircraft can only fly so high. And should the turbo-charger fail it will start coming down and coming down very fast.

So I look at this market and see the early signs of Hypoxia. The euphoria appears to be setting in; although it can last for quite awhile the end result is far from pleasant.

That’s just my thoughts on the subject.

Trade with caution and I wish you the best of luck in your results.

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No More Blood in the Turnip

Posted October 8, 2014 By Phil Elrod

I seldom trade the futures market for gold and silver anymore, but I watch those markets regularly. What I look for is what is happening right now. The manipulators have been sucking blood from the turnip and I am thinking there is not much blood left – that we are getting real close to a bottom. I am writing this at about noon, October 8, 2014.

The situation is silver is particularly interesting. The connection between the paper market (COMEX) and the market for the metal itself is seriously out of whack. The cost of producing silver is more than the current paper futures price (just over $17 per ounce) – and the supply of silver is tight. That combination is indicative of a likely adjustment in the very near future.

Take all of the above and toss in the fact that there have been unusual movements of physical silver of late (the silver ETF has had massive inputs of the metal) and I can make a pretty good case that the manipulators are positioning themselves for a big move upward. The recent depression of silver has been a case of commercials buying as the price falls and the tech funds selling and shorting. Currently the tech funds are massively short silver. It would appear that the shepherd has gathered just about all the sheep he can expect for the coming slaughter.

I do not know what the future holds, but the probability of silver being driven down further seems small. On the other hand the possibility of a very large move to the upside is within reason. The futures market is so volatile when these moves take place that I just had to swear off trading them. But physical metal is still a viable means of playing these moves. And buying at – or very near – the bottom for a commodity usually results in a good trade. In my opinion, silver at the current price, is a screaming buy.

The next week or so should be really interesting in the market for silver. If I am right we will see a pretty significant correction in the price of the shiny metal.

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