Volatility can be your friend

Wednesday, 9 September 2019
Melbourne, Australia
By Murray Dawes

  • Odds of US–China trade deal are falling
  • Markets

As we race towards the restart of negotiations between the US and China, the markets are becoming more jittery. News last night that President Trump would be taking action against human rights abuses in China rattled investors and they sold stocks despite the news that the US Fed would be increasing the size of their balance sheet once again. (But don’t call it QE4.)

In a not so surprising move, the US Fed announced last night that they would be resuming permanent open market operations (POMO) after a five-year break. According to JPMorgan the $21 billion in monthly 10-year equivalent TSY purchases will be equivalent to QE1.

But Chairman Powell was adamant last night that the resumption of POMO was not in fact QE4. He said, ‘I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis’. And just to drive the point home, he stated ‘in no sense is this QE’.

So the US Fed is about to start increasing the size of their balance sheet with permanent open market operations but it isn’t QE. Welcome to the twilight zone.

The fact that the markets didn’t spike higher on the news and instead reacted to the potential that US–China trade negotiations were still under a cloud is very interesting from a trading perspective.

Odds of US–China trade deal are falling



chart image
Source: Zerohedge.com
Click to enlarge

When news comes out that should be incredibly bullish, but the market sells off instead, it gives you a very powerful insight into the underlying strength of the market.

I have started a weekly video called ‘The Week Ahead’, which you will be receiving every Monday from now on. You have already received a few instalments of the video over the past couple of weeks. In the videos I have been analysing the current state of affairs in the S&P 500 and pointing out why I thought it was about to sell-off.

If you want to check out the videos that I have been releasing you can find them here.

Making sweeping statements about the future path of the markets is one thing, but backing it up with actual trading advice is where the rubber meets the road. Members of my trading service Alpha Wave Trader have sold the E-mini S&P 500 futures short from 2980 and we have already taken part profits at 2915. The E-mini S&P 500 December futures closed at 2893 this morning.

Markets

The S&P 500 fell and gold spiked after news emerged that President Trump is taking action against human rights abuses in China which lower the odds of a US–China trade deal. The S&P 500 fell over 1.5% or 45 points to 2893 and gold jumped nearly 1% to US$1,505.

WTI Crude Oil dropped back below $53 ahead of tonight’s API inventory data.

The Australian dollar continues to hover near multi-year lows and was recently trading at 67.40 US cents.

US 30-year yields continue to fall and are approaching the 2% level again, last trading at a yield of 2.04%.

Dr Copper is looking decidedly sick with prices nearing a three-year low of $1.45. Prices closed at $1.57 in yesterday’s trading.

Now that the S&P 500 has reached my initial target, the breakeven price for the whole trade is above the all-time high. So the hard work has been done and we’re just sitting back and seeing what happens from here. With a stop-loss at the point where we breakeven on the whole trade, we will either breakeven or make money from this point, which is equivalent to a free put option with a strike price above the all-time high.

That’s a very powerful position to be in.

The reason I mention it is that I believe the reason you are reading this article rather than reading the sports section of the paper, is because you want to work on your investing skills and increase the returns on your portfolio.

Keeping up to date with financial news can be counterproductive unless you have an overall plan of action. There is so much news out there that you could spend your life reading it and still be none the wiser and certainly no richer. A million different viewpoints all vying for your attention and ultimately confusing you. That’s how I see a lot of financial news.

I don’t want to be another voice adding to your confusion. I’d rather be adding to your knowledge and helping you navigate the markets in a sensible and logical way.

As rates plummet towards zero, we’re all scratching our heads wondering how on Earth we’re going to meet our financial goals in the years to come. It is quite a conundrum.

We are all being forced up the risk curve, but the main point I want to make is that just because you’re being forced into a riskier end of the market doesn’t mean you have to behave in a risky way.

My solution to the search for higher yields is to use a trading methodology to enter into stock market investments. I think there are plenty of great companies out there doing incredible things and whether the S&P 500 sells off sharply from here or not (I reckon it will), those companies will continue to plod along building up their businesses in sectors of the market that are growing strongly.

The smaller to mid-cap space isn’t overrun by the algorithmic trader’s front running everyone. It doesn’t have the big funds on board shoving the price around to their benefit. The way they move is far more natural, being based on supply and demand.

They are perfect candidates for a sound technical analysis approach that picks up on insider buying before anyone else knows what’s going on.

The way I navigate the heightened risk is to look for points where I believe there is a good chance for mean reversion. I will take a third profit near the midpoint of the current range and then adjust the stop-loss to a breakeven level for the whole trade.

There are a few reasons why I do this and it’s worth thinking about if you are doing any trading or investing in the stock market.

I take part-profit as quickly as possible so that my mental state goes from one of high stress to not caring at all about what happens. Once part-profit has been taken as in the live E-mini S&P 500 trade that I told you about above, anything that happens from that point is OK with me.

Knowing that my initial capital is safe is very calming. I may be slightly upset if the market turns and stops us out, but the fact is the stop-loss is at a point where I am happy to be stopped out. If the S&P 500 does go and create new all-time highs from here, there is no way that I want to stay short. I will be happy to get stopped out because there is a chance the market could rocket higher in a straight line.

By having a breakeven stop-loss above the all-time high, it means the market must do a lot of work and break above a lot of resistance to take us out. I like that.

The markets are incredibly volatile. No one knows the future and the market is masterful at stopping out short-term traders before having a big move. I want to ensure that I give the market plenty of room to move. I want to be forced out of my position at a point where I accept that I am wrong.

Too many times in the past I have set stop-losses at a point based on dollars rather than on what the market is doing. No more.

Trailing stops may be useful in a later stage of a trade, but I think early on you want to give the market plenty of room. If you have trailing stops it is highly likely that they will be hit and you will be taken out of the trade for a level of profit that may be far below what you could have made if you just allowed the market to be as volatile as it is.

The reason why I have started up the weekly videos for you is so I can show you directly on my charting platform the reasons behind the way I trade. It would be far too confusing for me to describe the ins and outs of my technical analysis system with words alone. When you see the charts and I can draw on them to show you exactly what I mean, a complex subject can be unravelled quickly.

If you have ever had an interest in charting techniques or even if you are completely sceptical but are willing to hear a different point of view, be sure to be on the lookout for my ‘Week Ahead’ videos every Monday.

If you’d like to find out more about my trading service Alpha Wave Trader, go here.

Regards,
Murray