As a trader, waiting for something to happen is sometimes agony. Whereas value investors are not the least concerned with day-to-day wriggles in the price, swing traders have to scrutinise every short-term move. And when the market is doing very little, traders tend to become impatient.
But impatience can lead to mistakes. Consider, for example, the FTSE, which has been trading between my tramlines on the hourly chart for almost a month. On Friday, I showed that this range-bound trading has been characterised by deeply overlapping waves – a sign of a counter-trend consolidation, rather than a change of trend.
As the whole world knows this morning, there was a nuclear deal struck with Iran over the weekend. This has sent markets into a slight spin, with the overnight US stock markets reaching new highs, as well as big declines in crude oil.
But since this seemingly bullish news has come after an almost five-year rally in shares, as a trader I have to ask the question: is that it?
In other words, could this news top off the rally?
Buy the rumour, sell the news
There is a popular trading maxim: buy the rumour, then sell the news.
When there is doubt and indecision in the market (the rumour phase), the bulls can push prices up because the conviction of the bears is weak without firm news.
But when the news is out, many bears will quickly rush to cover their shorts in order to prevent even bigger losses. When this is combined with buying by ‘late to the party’ bulls, who jump on the news as a great reason to buy, there will be an upward spike.
This spike is a godsend to professional traders, who bought the rumour and now sell into the rally, thereby taking their profits.
Astute traders will normally sit back and observe market action over the next few hours to see whether the upward thrust can be maintained.
Time to be patient
If the selling by the professionals, together with other profit-taking and new selling by the bears can swamp the remaining buying pressure, then prices will fall back.
But if the buying is strong, the gains will be held. That’s when the bears have a decision to make: do they hold on in the face of a strong bull market, or do they throw in the towel?
This to-and-fro action between the bulls and bears can last some time. That is why it is a good idea to just observe the market and see if one side eventually dominates.
One possibility is for the market to run into huge selling pressure later in the day and produce a key reversal.
This is where the market, following a big rally, makes a new high but closes lower on the day, producing a big red candle on the daily chart. Sometimes, this indicates a change in trend. An even better trend change indicator is for this key reversal to occur on the weekly chart.
No major changes in the FTSE
While US markets have moved up sharply this morning, the same cannot be said for the FTSE, which still remains under my upper tramline:
The reaction of the FTSE to the Iran news has been more muted than in the US. This is because the natural resource companies that dominate the FTSE could suffer because of the pressure on oil prices.
But gazing at the chart, the market’s reaction to the Iran news is indistinguishable from the other minor wriggles – that is an indicator of how the market is taking it, so far.
The first markets to open this morning are in Asia and Australia/New Zealand. And London has just opened. But it will be the reaction of the US markets later today that many will be watching.
Don’t second guess yourself
So now, we have at least seven touch points on my upper tramline. The question is: will it finally break through this time? And if it does, will the break be a head fake or a genuine thrust?
Sadly, there is no way of judging this in advance with absolute certainty.
As a disciplined trader, you have to go with your method. If it is telling you to go long on an upper tramline break, then you must do it. There should be no second-guessing.
Your protective stop will then need to be placed just under the tramline using the 3% rule.
Of course, you always have the option of sitting on the sidelines. Normally, that is a good place to be for much of the time.
If you are a trader who only picks the very best opportunities, then you will need to see all of your indicators line up – and these don’t come along very often!