Sunday, August 30, 2015

That was the week that was

Last week will have been an educational experience for many people, particularly those who have started trading since 2008.

Since the major market averages bottomed out in early 2009, they have generally been in a steady uptrend. There have been one or two short periods where there has been some downside volatility (August 2011 and early October 2014 spring to mind) but they were small beer to what happened over the last few sessions.

Then again, we still need to put this into perspective, particularly with people calling the beginning of the week a crash or even 'Black Monday'. Last Monday, the FTSE and DAX fell more than 5%, and the Dow fell just over 3.5%, although intra-day it fell a lot more. Back in 2008, the Dow fell more than 7% on more than one occasion.  And further back in 1987, the Dow fell more than 22% in on the real 'Black Monday' - now that's a crash!

Many people who are relatively new to trading will now know there is real 'fire' in the markets. They will not have seen such price movements and intra-day volatility. As a result, while it was possible for those with the required skill and risk control levels to make money, it was also easy for others to lose a significant sum of money in a (very) short period of time.

Below is a chart of the Dow. As you can see, the current 2ATR measurement has spiked up to just below 600 - and that is with the Dow in the 16,000 area. As a comparison, back in 2008 the 2ATR on the Dow peaked at over 1,000 - and that was with the Dow down around the 10,000 level. So it is all relative. Yes - the markets have turned extremely volatile compared to the last few years, but nowhere the 2008 levels. Given some of the headlines and social media comments I have seen the last few days, goodness knows what they would have been like had volatility reached the levels of seven years ago!

As I mentioned in this post last weekend, there was certainly potential for a sharp drop, and there were some parallels with price action back in September/October 1987. As it is , we saw a sharp drop on the Monday, before a rally over the rest of the week. I've also talked in the past how difficult 'V' shaped reversals are to deal with, particularly if you employ a trend following approach. Price does not allow for the trailing stop to start moving down quickly enough to lock in some of the profits generated by going short. Have the markets just done that? Who knows. You just don't know what is going to happen.

Sensing an opportunity, the 'buy the dip' brigade came out in full force, causing prices to rally. However, there are some big differences between this recent bounce and previous dip buying:
  • Price levels fell below long-term moving averages which are used by many in basic trend analysis;
  • Classic Dow theory has also recently flashed a sell signal;
  • Some of the better 'buy the dip' traders I know have switched sides to 'short the rallies';
  • Even just looking at a naked price chart, many major indices are now showing an emerging pattern of lower highs and lower lows. Until that pattern is negated, then the trend appears to be downwards.
As always, time (and price action) will tell us who is right and who is wrong.

As for my own trading, my scans have been obliterated this week. Due to the expansion in volatility, almost nothing - long or short - is currently showing. Again, my approach is indicating to me to stay out of the market for the time being. Yes there will be opportunities that will crop up, but not just at the moment.

It is far too early to say whether we are out of the woods with this one, or if the markets are still in the process of rallying before forming a lower high. Should they do such a thing, and then start to approach the lows made early last week, it will be more than interesting to see the reaction of the financial media and other market participants!



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