This year marks the 75th anniversary of the start of World War II. From 1939 until the Battle of El Alamein in 1942, the Allies were constantly on the back foot. But that battle, which took place in Egypt, was a turning point – it was the first convincing win of the war for the Allies. From that point on, they rarely looked back until the war ended in 1945 (in Europe, at least).
In that war, most knew who the good guys and the bad guys were.
Now, you’re probably wondering what this little history lesson has to do with trading the financial markets.
Actually, the financial markets are very much like a battleground. The bulls are pitted against the bears in a battle for supremacy. Ground is won and lost. The firepower for both sides is provided by the funds available.
A mass of confident (and well-supplied) bulls can overpower a weaker and less well-supplied army of bears and push the market higher until their supply lines of funds depletes. The bears then see their chance and push the enemy back and retake territory they had lost. And there are lots of casualties along the way – some fatal (in trading terms).
In fact, the ancient Chinese treatise The Art of War is recommended reading for neophyte hedge fund traders. I am sure it helps ramp up their most aggressive instincts.
It is this constant to and fro of the forces that produce the market swings that I am trying to capitalise on. And such movement creates the chart patterns that I try to identify and trade.
Good guys and bad guys in the markets
To continue the comparison, the good guys in the markets are considered the bulls, who push prices up (in the eyes of the media, at least). The bad guys are the bears who try to push them down. Rising prices are always to be celebrated in the media, while falling prices are bad news.
For the past five years, stock markets have been clearly dominated by the bulls, with only brief losses to the bears. They have been rampant – and have taken much territory with the S&P 500 hitting an all-time high of close to 19,000 on Friday.
But at around 2.30pm UK time, just as the bulls were digesting another ‘supportive’ US employment report for March, waves of selling hit the markets and the Nasdaq closed the session to record its steepest daily loss in several years (and a break of an important tramline).
So what happened at 2.30pm to alter the landscape? Did a bell ring at the top? Did a market-moving news item hit the wires? Did the bulls suddenly decide that now is a good time to book profits based on just gut feel?
Of course not. And we will never know the ‘reason’ – that is why it is futile looking for it. The charts hold all the information a swing trader needs.
The tide has finally turned
Here is the five-year battle in the S&P 500:
I posted this chart last month and wondered if the symmetry would hold. In other words, would there be a major top in the March/April period? The low was put in on 6 March 2009 and my B wave low was made in September 2011 – 30 months later.
This symmetry of highs and lows is characteristic of a market cycle. We haven’t heard much about cycles in recent years – mainly because stocks have been a one-way street. In previous periods, when stocks were exhibiting wide swings, the study of cycles was of major interest. Many books are published on the subject when markets were more two-way.
I would venture to say that when you see many cycle books appear, that is when cycles stop working (and vice versa). Currently, we are in a publication low point.
So, how can I say that the the tide has turned? Looking at the above chart, the dip so far is just market noise, surely? To paraphrase a famous Chinese quote: The journey of a thousand pips starts with a single dip.
MoneyWeek Trader is our FREE spread betting & trading email offering you the very best tips, secrets and guidance from our trading expert, John Burford, who has years of first-hand experience.
The chart that says it all
Let’s zoom in for a closer look in the Dow:
This chart says it all!
• Five clear waves up for the final push to all-time high at 16,650 on Friday.
• Huge negative-momentum divergence from wave 1 – an unusually long period. This laid the ground for Friday’s massive rally failure at wave 5.
• Great tramlines with the lower line broken Friday afternoon in a cascade of selling.
Odds are now very high that my C wave (top chart) and the above fifth wave are coincident. If so, the trend has now changed to down. Friday’s late action has done a lot of damage to the bulls’ confidence.
How to predict a bull market turn
As I write, the Dow has retreated to the Fibonacci 62% retrace of the last leg up where it may find support. If so, then the current price would mark a large wave 1 down, leading to a relief rally in wave 2.
The latest COT (commitments of traders) data shows the specs had ramped up their bullish trades – right on cue, just before the crash. Here is the Nasdaq data:
|(Nasdaq 100 stock index x $20)||Open interest: 366,668|
|Changes from 03/25/14 (Change in open interest: -12,042)|
|Percent of open in terest for each category of traders|
|Number of traders in each category (Total traders: 210)|
As of last Tuesday, the hedgies are over three-to-one bullish, while the small speculators are not far behind. Remember, bull market turns are always accompanied by a high degree of bullish sentiment. They cannot turn unless the bulls are in total control at the turn.
That is why major turns often occur at times when the news is especially ‘good’. This is when the bears are in hibernation.
Markets ‘fall out of the window quickly’
In recent posts on EUR/USD and GBP/USD, I showed how great trades can be made by following the market up, drawing the trendline and placing a resting order to short the market on a trendline break. Another stunning example of this procedure can be seen in the Dow trade, where there is already a gain of over 200 pips.
In just a few hours, the market has lost what it took five days to make. The cliff-like pattern proves the old adage: Markets climb the stairs slowly and fall out of the window quickly. That is why a trader can accumulate big profits much more quickly on the short side than the long.
So now the battle is on. Will the bulls retreat and give up even more ground, or will they dig in and hold their territory? For the first time in many months, it appears the battle is joined.
If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together