Sunday, December 30, 2012

Fiscal cliff and other market unknowns

The buzz words or phrase that everyone is referring to at the moment is 'Fiscal Cliff', and the possible impact it will have on the US economy, as well as the markets.

As it happens, the US indices have performed an abrupt about turn over the last few sessions of the year, and are now on short signals. Perhaps unsurprisingly, the major European indices are showing greater strength, but are also being dragged down in concert.

In its purest form, trend following means watching what the charts are telling you, and acting accordingly. The reasons or catalysts for a movement or a change in the trend are unimportant, as price is the sole metric to follow.

The US futures are being shown to be down over 200 points as I type this (Sunday evening UK time), and the next 24-48 hours promise to be highly volatile.

When there are major events such as these occurring, individual traders have an advantage over institutional investors - if they wish, they can exit the markets and stay on the sidelines, until volatility subsides and market conditions improve. Similar to this, some people I know who trade stocks using a trend following strategy have incorporated additional rules governing whether to hold stocks through earnings.

When the markets closed on Friday, there would have been no way of knowing whether the Fiscal Cliff was going to be avoided, and some form of agreement reached, or that the political deadlock would have remained, with the inevitable consequences for the markets. In times like these, there is scope for tremendous rewards, if you get the direction right, or the potential for big losses if you trade in the wrong direction. That again, is something that a trader can factor into his own trading plan.

As I have mentioned in previous posts, cash is also a position, and you do not have to be in the market at all times. I have strict limits as to how many positions I can open per day, and as a result I have not been fully invested for a while, due to the changes in the market trend. And for that I am grateful, as this constant whipsawing has eroded some of the profits made earlier in the year.

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