How I’m Trading This Emotional Market
01/31/2011 11:12 am EST
Mr. Market has thrown traders a few curveballs lately as precious metals and crude oil have been selling off while the US dollar index futures were consolidating. Additionally, the volatility index has been very choppy and was indicating that we could be seeing a potential change in the underlying trend with regards to future price action. In previous MoneyShow.com articles, I warned of a likely correction in gold and equities as prices were extremely overbought and both asset classes were due for pullbacks.
Precious metals have been selling off for much of the month of January, while equities worked their way higher as technology stocks continued to outperform. Today we are seeing major selling in equities, while gold, oil futures, and dollar index futures rally. What is Mr. Market trying to tell us? Why are the US dollar index futures rallying with gold and oil simultaneously? However, the most important question that most traders want an answer to is whether this is a top in equities or if we are just going to have a mild correction and power higher?
Risk was excruciatingly high and Friday’s price action appeared to be extremely emotional. I am watching to see if we get a new grind higher in equities, which generally is accompanied by light volume. If equity prices are held down today, we may see lower prices in the not-so-distant future. The daily chart of the S&P 500 e-mini futures contract listed below illustrates the key price levels that traders are likely watching closely:
I remain neutral on stocks at this point, as I want to see how the market digests Friday’s prices before taking a serious position. With short-term prices at the current oversold levels, I am expecting a light volume drift higher before Mr. Market tells us which direction he may be headed in the longer-term time frame. For right now, I will continue to remain in cash and will wait patiently for low-risk, high-probability set-ups to emerge.
NEXT: What's a Gold Trader to Do Now?|pagebreak|
Gold futures suffered from a relatively serious pullback in the month of January. At the close last Thursday, gold was trading around $1,315 per troy ounce. As of the writing of this article, gold was trading over 15 points higher on Friday and panic buying was taking place. Gold was extremely oversold on the short to intermediate time frame, so a relief rally was expected. However, gold rallying 15 points in the face of an increase in the dollar futures on Friday was rather perplexing. The US dollar index futures are illustrated below:
There have been times when both gold and the dollar have rallied together in the past, however, at this point, it is too early to determine what the market is trying to tell us. On one hand, it is obvious that gold needed to bounce to work off oversold conditions. On the other hand, it is rather odd that gold and the US dollar index futures are rallying together. My best guess is that traders are trying to gauge where future money flows are going to be placed if selling persists in the future. It is hard to say for sure if gold will roll over or if this rally is trying to tell us something else.
Currently, it is too early to tell, so I will continue to sit on the sidelines and watch the price action. I do not have an edge, and the “whippy” price action in gold futures recently has not offered a solid risk/reward set-up. Longer term, I expect gold prices to work higher, but in the interim, I am unsure of price direction, and if selling pressure sets in, how low prices might go. Key support levels in gold futures would be around the 1270-1280 range based on the gold futures chart illustrated below:
For right now, I expect that gold prices could drift higher, but the decline may or may not be over. There are extraneous events that could trigger another powerful rally in gold, particularly if panic selling in equities continues and/or an unforeseen event occurs in Europe or the Middle East. I do not currently have a position in gold futures or gold ETF GLD, but I will be watching the price action closely awaiting a possible trade entry. I will likely look to get long GLD at some point in the future, as I expect another rally to transpire in coming months that might push gold to new highs. It is too early to tell what price action is going to do, but for right now, I’m going to sit in cash and wait for a solid low-risk, high-probability set-up.
Right now I am sitting in cash and will likely remain that way until we get further confirmation in both the S&P 500 and the gold futures market. It remains to be seen if this is the beginning of a new trend or a possible topping formation in the S&P 500, but what is known for sure is that we have seen heavy volume distribution set in last Friday and panic selling levels have been reached. The marketplace is charged with emotion and the VIX is up more than 20%. This type of environment is not conducive to my style of trading, so I will sit on the sidelines in cash and wait for an entry to take shape.
Gold is also at a rather tricky point on its chart as we have seen a significant rally recently, but it remains to be seen whether this is the beginning of another powerful rally or whether we are just working off the oversold condition. Sometimes it pays to be patient as a trader and wait for set-ups that offer a high probability of success while risk levels are mitigated. Right now I’m going to go into this week entirely in cash with a smile on my face.
This week, however, could offer some interesting trading set-ups on the S&P 500 and gold futures. Should a quality set-up arrive, I will most certainly accept risk and put my trading capital to work. I hate losing trading capital, and price action today is far too emotional to get me involved. I would rather enter positions when the crowd is either sleeping or looking the other direction than invest my hard-earned trading capital with them. You can call me a contrarian, but please do not make me hang out with the crowd!
By J.W. Jones of OptionsTradingSignals.com