Markets now are a trader’s paradise

The huge surge in volatility recently has made the markets a trader’s playground. Daily swings of many hundreds of Dow points have been the norm.

Fear is now stalking the markets. The VIX fear index shows that the market has been roused from its complacent pre-Black Monday slumber to a sudden state of terror:

VIX market volatility chart

When markets suddenly switch from a somnolent state of bullishness to a state of fear, that spells opportunity for alert traders – especially on the short side. And that is where my tramline methods start paying their way.

But for buy-and-hold investors, the action has been totally out of character (at least since 2009) – and is doubtless giving many sleepless nights.

I have been following many of the twists and turns in the Dow in these articles and highlighting how terrific swing trades were made in the past few days by simply following the signals offered by my tramline method.

Here is another one.

I found the perfect place to short the Dow

On Friday, I drew a new roadmap for the Dow. The Black Monday wipe-out low was my wave 3 of a to-be-completed five down. And all of last week was taken up by the relief rally in wave 4 which was following the traditional A-B-C pattern I had forecast earlier in the week:

Spread betting chart

I thought the rally on Tuesday was unlikely to be the final wave 4 top because it was too brief. I felt there was one more rally to a new relief high in store – hopefully to the Fibonacci 50% or even 62% retrace of the entire wave down.

As Friday dawned, I noted the lovely five wave pattern to my C wave, which had hit the Fibonacci 62% level on a negative momentum divergence. Bullseye! That was the place to enter new short trades; the odds were high that I had found the wave 4 top and the market would then move down, especially after it broke below the lower tramline, which it did later on Friday.

And on Bank Holiday Monday – it pays to be awake at all times! – the market opened down with a very large gap:

Spread betting chart

On Monday and Tuesday, the market moved down by over 700 points off last week’s high – and offered a terrific three-day profit if taken.

Why would you take the profit there? Well, here’s a great reason:

Spread betting chart

The move down hit the Fibonacci 50% support level on the nose – and on a positive momentum divergence to boot!  The odds were high that the market would stage a bounce – and taking the profit was a prudent play. As I write, we are in that bounce.

Note that I did not use guesswork, or gut feel to make a decision – I used the well-established rules and guidelines of my tramline method.

This morning, I have two alternative paths: either the market will go on to make a new wave 4 high, or the rally will top out under the 16,700 area and resume its path along wave 5.

The news really does follow the market

I came across a report in the Sunday press titled: “Early shutdown on cards for 40 North Sea platforms”. Of course, this followed last week’s huge surge in the US crude oil market from a $39 low to Friday’s high of almost $46. Note that the news followed the surge in price, and did not lead it.

As anyone who has studied economics will know, a low price is a cure for a low price. Prices that fall under costs of production inevitably lead to production shut-downs and curtailment of exploration plans and make future supplies tighter. Of course, these seismic shifts in production levels take time to work through. But markets are very good at anticipating these changing dynamics.

Traders must also anticipate these developments. If you are using the news to guide your trades, you are usually too late to catch the turns. It is often a case of shoot first, ask questions later.

But that is what the art of tramline trading is designed to do – it offers rules and guidelines that can be followed with scant regard to the current news.

Let’s look at yet another great example of the news following the markets. US crude has rallied over $10 in only three days – its biggest gain in over 20 years. Overnight on Monday, reports that US crude production was being revised downwards along with OPEC’s willingness to discuss output curbs emerged.

Naturally, the ‘buy the rumour sell the news’ boys were busy taking profits on that. And the market is easing off its highs as early birds are selling to the latecomers who follow the news (and buying at a top).

There is no doubt that the historic swings we are witnessing in many markets are the result of fundamental shifts in investor/trader sentiment – and social mood generally. There has been a near-consensus view that with central banks willing and able to pump as much liquidity into propping up asset markets, markets will never collapse.

This view is now being exposed for what it always was – a reflection of a bullish mania that has bred historic complacency. And after complacency comes panic.