Market Update Post Fed – Lessons in Price action
I see an uptrend like the recent one in the indexes and expect to see the reverse happen. This is because recency bias conditions our primitive DNA to expect everything in context with what came just before.
But that doesn’t work with markets. Like with so many things, our hunter gatherer DNA is ill equipped to deal with the modern world.
Burn this into your brains.
The highest probability following any period of smooth, easy to trade, single direction price movement is a period of choppy, two sided, difficult to trade price action. We call this easytime-hardtime, and it is a very good paradigm for viewing the markets.
So we look and see a reversal coming, what is far more likely is for us to have a period of choppy, hard to trade price action like in crude recently.
Al Brooks has this concept, and he has a neat method of dealing with it. When he sees tape he calls “barbed wire” with lots of overlapping bars, few series of directional moves, choppy unpredictable price action, he just stops trading to give it time to sort itself out. Where there is no edge, there is no edge. We see this all the time in our systems, they outperform, and then underperform in maddeningly clustered fashion.
How can we tell that trends are coming to an end? Trends primarily in two ways on any given timeframes. With a bang, and with a whimper. Either 2001, or 2008.
Both of these situations are very different. One has decreasing volatility with an uptick in volatility towards the final phase. The other has increasing volatility to a historic point.
What does this mean in context for the indexes right now? The move since the Trump ascendency clearly is a decreasing volatility melt up. In decreasing vola melt ups technically perfect counter trend setups appear, which don’t work.
This fuels the frustration of the other side, they are sure the market will reverse, but after so many failed attempts at shorting, they don’t have the guts to get long. Until they do. Mostly these trends end when the sideline bulls who “didn’t trust this rally” finally capitulate and get long. This usually happens after a period of historically small candles, or more correctly, unsustainable low volatility.
The evidence here is compelling. We have a low vola melt up, we have a huge spike. We have a choppy fall for 6 trading days and a choppy rally. The market is likely retesting the old highs in anticipation of forming a trading range.
There is a pronounced “vacuum effect” in trading ranges once they become obvious. Why would a short seller get positioned in the middle of a trading range when he knows it will probably retest the highs enabling him to get a better fill?
Short answer – he won’t, he will be standing aside. And short sellers avoid the middle of trading ranges, because they are really really difficult to trade, and you kind of suspect they will get to the highs anyway. So this can have the effect of making one side seem stronger than they really are. That is what happened yesterday in my opinion. In context I still believe the rally is stinky, but we will see more when we reach the old highs.
Take a look in the trading range breakdown off crude. There are a few lessons in this. Trading ranges end SLOWLY. Imagine an epic 12 round prizefight. A trading range is like that, it ends because one side is too weakened to continue, not by one side landing a knockout blow in the first round.
Also, we get clues of buying or selling pressure towards the end of the trading range. When we start to see consecutive runs of 3 or more candles in the one direction, or points where there should be buying activity but isn’t… our spidey sense tingles.
Back on the system building tomorrow.