Wednesday, January 13, 2016

Is this price action different?


My guess is that there are plenty of people trading now who didn't participate in the markets in 2008. Since the market bottomed out in March 2009, there has been a long uptrend, although the major averages have certainly struggled to make new highs in recent times.

It is possible we are now seeing a different market - one where traders who continually apply the same rules  that will have worked since 2009 (such as the 'buy the dip' brigade) will get their fingers burnt. As a result, those people relatively new to the markets are all set up for an important educational experience. Hopefully they will keep their tuition fee as cheap as possible.

There really is fire in the markets - those who experienced August 2011 or August 2015 will have had a taster. But they weren't on the scale of 2008.

For trend followers, the rules are pretty simple. The basic premise is that you look to go long on new highs, and go short on new lows. Therefore, you will generally find that you are going long during longer-term uptrends, and going short during market downtrends.

Generally speaking, in downtrends prices tend to move faster than in uptrends - hence the phrase 'take the stairs up, and the elevator down'. The counter-trend rallies can also be vicious.

2008 was the last prolonged downtrend that we had to deal with. Those who were prepared to accept that prices can go down as well as up, and trading accordingly, made money. Those that persisted to solely look to the long side would have been disappointed. As a result, trend followers did pretty well.

2016 so far has been pretty much one-way traffic - with prices moving in a downwards direction. Accept it, and trade accordingly or move to cash if you are uncomfortable shorting.

You don't even have to look at the indices - individual stocks, foreign exchange pairs or commodities exhibit the same characteristics.

Look at crude oil. This has fallen from above $100 down to around the $30 level in 18 months. People who have continually tried to buy at the bottom will have lost. Meanwhile, those who who have traded this market on the short side should have profited handsomely.

When a trend follower is normally asked about price targets, we tend to say that it is 'to the moon' or infinity on the upside, and zero on the downside. As it happens, I've started to see some comments on social media over the last few days saying that that zero is a decent support level on crude oil.

It is far too early to say if we are on the cusp of a market market downtrend similar to eight years ago. Subsequent price action will let us know. However, those who trade in the direction of the market will be best prepared to deal with what could be thrown at them.

Larry Hite said this in his Market Wizards interview:

"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 price is at a new high tells you something has changed."

This also applies when prices fall to new lows. How you determine 'historic' for trading purposes will depend on your chosen parameters. But the basic principle is exactly the same.

Finally, here is something else Larry Hite said towards the end of his interview which is sound, timeless advice worth following:

"I knew that if you traded across the board, controlled your risk, and went with the trend, it just had to work."

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