Event-driven markets are a common deterrent to many would-be technical analysts. After all, how can lines on a chart make sense of a market that appears to change direction on news events? A common refrain on business news programs during the recent credit crisis has been that the markets “are no longer trading on the fundamentals.” Other people thought that the markets were no longer trading on technicals. Most didn’t know what to think.
Thankfully, there is light to be shed on this topic. With the right technical tools and know-how, any trader can navigate these rough financial seas.
In his acceptance speech for a lifetime achievement award in service to this industry, legendary trader Richard Arms told the audience that everything anyone ever wanted to know about a stock or index could be found on a price chart. The price chart encompasses all of the hopes and fears of each market participant, and those hopes and fears are reflected in the current price. The technical situation not only reflects supply and demand but fear and greed. If you can wrap your mind around that concept, the battle is half won.
It’s a common notion that news drives price action. In reality, the opposite is true. The current technical situation, as expressed by universal price and time relationships, drives future price action. This is true in every case. We are only limited by our understanding of what materializes on a price chart.
IT GOES BOTH WAYS
The challenge for many traders is that the technical situation may be too complex to understand. During these times, it’s tempting to assume certain price moves are driven by current news or events, and, worse, trade on those assumptions. Luckily, technical situations aren’t always so complicated. There are enough situations where price and time make sense and most traders can put the pieces of the puzzle together.
On any given day, the media spins its explanation for current market action by the major news story of the day. On some days, a market decline will be blamed on rising unemployment. On other days, a major company layoff will be credited for a market rally; these apparent anomalies should inspire doubt for the diligent trader. Bull markets climb a wall of worry, and in a bear market, we slide down a slope of hope. Markets will do what they must based on the technical situation; as a result, it often appears they are looking for an excuse to move toward a specific technical target.
A simple concept that is nonetheless sometimes difficult to grasp can help explain this. Markets move in three dimensions: price, time and volume. When markets hit price and time targets, the news event seems to manifest. You can never know what that event will be, but it seems to work over and over. This phenomenon has been going on for years, but 2008 was a historic period when many events materialized within the space of a few months. Because this was an unprecedented condition for our generation, many did not know what to make of it.
SEE AND LEARN
A few examples can help illustrate this concept.
One that had a major impact on markets was the July 15 low that sparked a decent bear market rally. The bear market was correcting the excesses of a real estate and banking crisis. Consequently, the housing and banking sectors led the market down.
On July 15, the KBW Bank Index (BKX) hit an important technical price and time cluster (see “Don’t bank on it,” right). The Futures articles “Trading Stocks with Fibonacci and Lucas” (May 2007) and “Finding Patterns with the Lucas Time Series” (September 2006) further explain how the time dimension of technical analysis can give the trader an edge in recognizing these patterns.
One repeating technical setup is a Fibonacci expansion based on the last leg of the old trend that projects important lows of the new trend. On July 15, the BKX came within ticks of the 2.618 expansion of the last leg up of its old bull market, and a cluster formed at 144 (Fibonacci) weeks. That was the day Fed Chairman Bernanke was grilled by the Senate Banking Committee for presiding over the subprime mess. That also was the day the Securities and Exchange Commission announced it would enforce naked selling rules and curb short-selling of Fannie Mae, Freddie Mac and other major financial institutions. The next day, a massive bear market rally kicked off. In the next 10 weeks, the BKX went from 46.54 to 83.37, which it hit on Sept. 19.
When markets do hit these technical markers, many times news events seem to manifest; traders must recognize the condition and be in a position to exploit it. Price and time clusters come in every degree of trend, all the way down to a five-minute chart. For those who are interested in trading news events, the simple way to understand this phenomenon is to track the technical conditions of the market. When a cluster of solid technical signals lines up, expect some important news event, then take a position when the market confirms the technical condition. In the case of BKX this summer, an exploratory short-term long position was warranted.
Another important event materialized when the House of Representatives approved the Troubled Asset Relief Program (TARP) bill for $700 billion on Oct. 3. This particular situation was more easily recognized on a five-minute chart. The prior sentiment among traders was for approval. Experienced traders know to buy on the rumor and sell on the news. The Dow traced out an A-B-C pattern before and during the vote and topped when the C leg was a multiple of 0.618 and A, which is a common technical relationship (see “Indexes correctus”).
In terms of intraday time cycles, the pattern completed in 47 Lucas bars. On the intraday chart, the tweezers setup at 47 bars, with follow through in the next few bars, provided traders with at least a short-term opportunity. What is not shown on this chart was that the daily candle opened above the low of the prior day, rallied up near the high of the prior day, and closed below the low of the prior four candles in an already serious downtrend.
On a usual trading day, the A-B-C condition might lead to an ordinary drop. However, Oct. 3 was not an
ordinary day. In terms of Fibonacci cycles, Oct. 3 was the 233rd trading day off the 2007 Nasdaq top. In ordinary circumstances, these Fibonacci windows produce good reversals. In this case, day 233 produced the acceleration of the trend. It’s the sort of condition that happens many times on intraday charts, but is a rare occurrence on a daily timeframe. The Dow dropped another 2,438 points in the next five trading days and the Nasdaq 405, which turned out to be the worst part of the crash period.
In yet another intraday opportunity that turned into a multiday trading bounce, the Senate vote, which failed to approve funds for Detroit’s automakers on Dec. 11, completed a bearish week of building negative sentiment. If experienced traders will buy on the rumor and sell on the news, they will also buy when nobody else is willing to stick their toe in the water.
In this case, the Senate vote occurred late on Thursday night and sentiment was not only bearish, it had an “end of the world” feeling because economists were predicting up to three million people could end up becoming unemployed if the automakers were allowed to fail. There was still one card to play as the president had the authority to release TARP funds. That announcement did not come until the next morning. By that time the day session of the E-mini market had gapped down but fell no further. This event coincided with the intraday 261 bar time window on the five-minute chart. This time window led to an 87 point rally in the tech indices and a 600 point bounce in the Dow.
Another important technical event of the fourth quarter materialized in the dollar (see “Turnaround play,” above). During this market crisis sequence, the dollar waged a huge rally that was an inverse play with the stock market. This setup was a bit complex but valid whether you were aware of it or not.
There are several components to this setup. The dollar traced out a triangle from Oct. 27 until Nov. 10. One way to target the end of a move after the triangle is to establish a Fibonacci relationship based on the expansion measured from the origin of the triangle to the completion. In this case, the dollar left a huge tail just short of a perfect 1.27 (square root of 1.618) expansion on 163 hours on Nov. 19. That was the calculation that created the end of the huge run in the dollar for 2008.
It took a couple of days for the dollar to follow through on that technical calculation, but a rumor surfaced that then-President-elect Barack Obama had selected Timothy Geithner to be the next secretary of the Treasury. The dollar started falling, and the stock market put in an intermediate-term bottom. Some saw the inverse dollar play and bought the market.
Observant traders should have asked themselves the following questions: With all of the news events that materialized since July, did it really make sense that the rumor of the Geithner appointment was the one that allowed the market to bottom? Was the calculation in the dollar, which had already materialized prior to the rumor, the real underlying structure that set up the dollar decline and stock market rally?
These four news events (three with descriptive charts) are a few examples of many that are tied to precise technical situations. In the least, the trader, as well as the media, may well be advised to reconsider the notion that technical events are no longer valid and market action is being driven by the extraordinary events of our times.
Traders must learn to trade successfully in this challenging environment. If a trader believes that everything is determined by fear/greed and supply/demand, and that both are expressed through the technical analysis of price, everything else will take care of itself.
Jeff Greenblatt is the director of Lucas Wave International. He is the author of “Breakthrough Strategies for Predicting Any Market,” a Marketplace book. E-mail him at firstname.lastname@example.org. Jeff Greenblatt’s presentation at the Futures I-Trade show is available for free at www.futuresmag.com.