Those that have trained with me know I like asking that question: what is the market trying to do?
I cannot remember where I picked it up. I think I overheard another trader saying it one day a long time ago.
The idea, well my idea at least, is to stop you from getting too caught up in your own opinion and trade what the market is doing.
Case in point: The US election and the bond markets.
Going into the election, I had this idea that a result for either candidate would see stocks higher and bonds lower. Particularly on the Trump side, even though common opinion was the opposite. I reasoned ‘what is it about a shrewd businessman that would be bad for an economy?’.
Hey, here in Au, the US and many other countries, there is a long list of ‘politicians’ that have more focus on their popularity than on actually managing economies. Perhaps a seasoned businessman might do a better job. My thoughts anyway.
Initially however, the market disagreed. Early signs of a Clinton victory triggered a rally in the S&P and a sell-off in bonds. Then, the shifting polls (towards Trump) triggered a complete reversal. The S&P fell and fell. If you were watching it live, it looked everything like a crash.
During that time, the key to trading well is to ask ‘what is the market trying to do?’. It was clear the bond trade to be in was from the long side and the S&P trade was from the short side. Stand in front of that and you got beaten up. Simple.
As below in the mini, 2100 was a key level. 2080 was a key level. The market smashed through both. Obvious point: don’t be long.
Likewise in the Tbond, don’t be short:
To trade ‘events’ like this, it’s good to have the inverse of the S&P on the screen. In fact, this is how I had it set up:
The bottom right chart shows the inverse S&P (code: 1/ep on CQG).
Remember the cause of volatility is uncertainty. When markets are uncertain, they look at other markets for clues on direction. Bonds were looking at S&P and S&P was looking at bonds.
The reason for the inverse chart is given the negative correlation between the two. Turning the S&P upside down meant I could trade the bond against the same ups and downs in the S&P. It’s easier to visualize compared with having the negative correlation in mind all the time.
As mentioned, early on bonds were up and S&P was down. If you were asking ‘what is the market trying to do?’, then your trade direction was as obvious as the nose on your face.
Then, as more as more numbers came in for Trump, something changed. It was as if the collective market said ‘hey hold on, this is going to happen and it might not be a bad thing’.
Here is how it played out:
The top chart is the Tbond and the bottom the inverse S&P. The inverse S&P made a high at point A, a higher high at point B then a marginally higher. Momentum was dying. You could look up your MACD or other momentum indicators and you’d see it. However, eyeballing the chart said the same thing.
Meanwhile in the bond, it made a high (A), a higher high (B) then a lower high (C). That was the change. That C point signaled the change in mood. Look at the chart again. It’s a nice head and shoulders, isn’t it?
Incidentally the same thing happened during Brexit, see below.
Back to the present, once the market turned from point C, or even if you waited until the shoulder line break at 163-07, you can be bearish and stay bearish. The S&P was in a bullish mode and bonds were falling.
In my opinion, this is where logic returned to the market (remember my shrewd businessman theory?).
Before this, asking the question ‘what is the market trying to do?’ gave you some OK trades. At least it stopped me putting on too many opinionated trades. After point C, the trades were not only logical, but a whole lot more obvious.
Lesson: always ask ‘what is the market trying to do?’.