Saturday, September 06, 2014

FTSE - are we finally ready?

For one brief moment this week, the FTSE attempted to breakout of its range which has been in place since last summer. This did not hold but price is still close to these levels. We were here before in May/early June, before price looked like it might try and go in the opposite direction in late July/early August. Now we are back to near those highs.

While the US markets have continually been making new highs over the last 18 months or so, the FTSE has stubbornly failed to break out into new territory. It is also worth noting there is an additional potential barrier in its way - its all time high which was achieved on December 31 1999, which is only 50 points or so away from this week's high.

The chart below is on the weekly timeframe and clearly shows the congestion over the last 15 months or so.

What is of particular interest to me is the ultra-low reading on the Volatility Factor indictor which I use. I've referred to this in the past as highlighting the 'coiling of a spring' as price consolidates. When price decides to finally breakout into fresh ground, then that volatility expands, and can lead to decent price trends.

"If there is a sudden expansion in a market that has been trading narrowly, human nature is to try and fade that price move. When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of the expansion" - Paul Tudor Jones

When trading individual stocks one thing we have noticed in our group is that a decent move starts on the day the VF reading is at its lowest for several months (we trade using the daily timeframe but the principle is exactly the same).

I've gone back and had a look over the last 30 years or so of data, to see when the VF readings were last at this level to see what happened next:

July 1996 - FTSE broke out the following month from around the 3,850 level (which was an all-time high at the time) and peaked in September 1997 at over 5,300.

June 2002 - FTSE fell from 5,000 down to below 3,300 in March 2003, which market the bottom of that downtrend. Prices haven't been that low since.

Summer 2004 - FTSE advanced from the 4,600 area up to over 6,000 in about 18 months.There was a brief sharp pullback in May 2006, and another in February 2007, after which price carried on up to its 2007 high at over 6,750.

In all three cases, the subsequent price trend was at least 30%. A similar sort of move now would take the FTSE close to 9,000!

Funnily enough, I also looked at the Dow for a comparison to see when its current VF reading was last at similar levels. This was in October/November 2005, when the Dow was hovering just below the 11,000 level. When it finally broke out at the beginning of 2006, it then moved up (with similar pullbacks to the FTSE) to its 2007 high at close to 14,200 - again, a near 30% move.

Now, I have absolutely no idea what will happen if price breaks out this time. I trade price. But I will heed what the market is telling me:

"When a market makes a historic high, it is telling you something. No matter how many people tell you why the market shouldn't be that high, or why nothing has changed, the mere fact that the price is at a new high tells you something has changed." - Larry Hite

While I'm writing this, no doubt some Smart Alec will refer back to my posts here about a two-way market, and a possible price fall. The beauty of being a trend follower is that you simply follow price - you do not trade on opinions or predictions. All big trends start out as small price movements. As it is the broader-based Russell 2000 has shown some strength in the last month or so (although it has not made new highs as yet), and the FTSE All-Share is mirroring the headline FTSE index.

If you are a trend follower, the bottom line is, if price starts moving in one direction, then that is the direction you should be looking to trade. If it changes direction, then you should look to also change the direction of your trades. However, you should also consider combining this with a contraction of volatility in price prior to the breakout occurring.

So, you can be sure that if FTSE does finally breakout in the coming days, you will know the direction I will be trading.

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