The Roman philosopher Seneca wasn’t talking about the stock market when he wrote that “T...
Where’s Your Edge in Trading?
03/04/2010 12:01 am EST
To succeed in trading futures—or in any market—one has to have some kind of an edge. We have stated how important it is to know the trend and trade with it. This is the first edge one can have—price momentum. What happens when there is no price momentum? Many who trade have a hard time adjusting to non-trending markets and can get chopped up from swings that turn with little direction, or turn just after it seems a direction is under way.
Here, I’ll show a selection of charts to demonstrate how markets are trending less and less over the past several months, and that increases risk exposure. Anytime you see a market in a trading range, your level of knowledge is at its lowest level, and price can go in either direction, much like tossing a coin. When your odds of trading successfully are at 50%, there is no edge. These charts reflect how price changes as a trend seems to develop, but goes nowhere, or changes direction.
A lack of an identifiable trend is an anathema for having a higher level of knowledge about price direction, and it increases risk exposure for less-definable results. The S&P had a labored rally for the last two months of 2009. Daily trading ranges were smaller and overlapping in a grind higher. January appeared to show a change in trend as price moved sharply lower on wider ranges and increased volume. Yet, there was no follow through after the February 5 low.
Usually, a market will have a countertrend retest rally, and the early February trading range stayed within a downtrend. There was a quick, one-day rally, and that led to another trading range. There was no reason to be long in a downtrend, so buying into that rally did not make sense. The way to trade was to look for a selling opportunity.
What has been happening is yet another failure to stop in a normal corrective rally, and instead, price has been holding, working higher. Right now, price is at the level where selling entered the market—January 21—a level of resistance. The daily trend is now marginally up, but there was no real transition from down to up.
Another example is the euro. This is a 240-minute chart, used by currency traders. A pip is used to denote a tick move, so 100 pips is the same as 100 ticks, or one cent. In a somewhat narrow, 350-pip trading range over the past month, there have been 2,450 pips in price swings, almost eight times the range. Try finding a trend to trade in that kind of environment!
In the currency markets, in general, many of the better moves occurred in overnight trade, and that only served to increase the risk factor during US trading hours.
The grains have not been any better. The downtrends stopped in February, but price has been range bound since mid-January. It usually takes some sideways trading to develop a base from which to launch a new trend, and grains appear to be doing that, but there has been no clear movement. A lack of any trend direction puts the level of knowledge for trading very low, and offers no edge.
One of the strongest markets has been gold. The swings have been larger in dollar amounts, but you can see that there has been no sustainable direction, and price remains where it was at the beginning of last December. The risk in metals has been greater, dollar-wise, because of the higher metal value, making the moves from day to day very expensive and often erratic.
No edge there, either. It is difficult to not trade, as most in the markets want to see activity, and they expect it. We have reduced our trading as a consequence of this kind of market environment. It is not a popular position, but when market positions offer risks equal to or greater than a perceived reward, it is an invitation to be in an environment to consistently lose money.
Markets go through phases, and we are in a transitional phase. Caveat emptor.
By Michael Noonan of EdgeTraderPlus.com
Related Articles on STRATEGIES
The Dow Theory was originally referred to as “Dow’s Theory,” since it was based on...
When stocks are selling at valuation extremes and consumer optimism is at one of the highest levels ...
The stock market is still bullish but it’s flashing yellow caution signals that are even brigh...