Archive for October, 2010

FX Land – A Look At The Technical Landscape

October 31, 2010 Leave a comment

Consensus is growing that the 'risk-on trade' has gotten ahead of itself in anticipation of another round of QE; setting up a "buy the rumor, sell the news" scenario. This looks very possible due to the excessive bullish sentiment across most asset classes reaching thresholds often seen prior to a reversal.

Over the course of the past two weeks the Dollar has showed signs of stabilizing, which could be confirmed if market participants take off risk after the Fed's announcement, however; the pause in downward momentum could be just that – a pause (consolidation). If the result after the pause is another thrust lower, provided how heavily everyone is betting against the Dollar, it would seem likely such a move would be the final leg before finding a meaningful bottom.

EURUSD – There is potential for a 4th-wave triangle, and a breakout of a fully developed pattern could take the Euro up to a very important downtrend line extending back to the peak in 2008. If the 4th-wave triangle comes to fruition, in accordance to Elliot Wave Principle, the thrust higher will represent the fifth, and ultimately, the final leg up since the June low. It would also satisfy an a-b-c corrective pattern. However, before reaching that conclusion, we must remain flexible; allowing for the possiblity that we have already seen the peak of the rally with ther recent high representing the end of a C wave. This week is likely to go a long ways towards validating either scenario.


GBPUSD – Currently this pair is testing a 16-month trend-line extending back to August of 2009, after bouncing sharply last week off the 50-day SMA/EMA and a 5-month uptrend line.The two trend-lines are quickly converging on one another, and thus put Sterling in a make or break situation. A 3-month triangle is also in the works with the apex falling near the convergence of the two before mentioned trend-lines.

AUDUSD – The Aussie broke a steep channel back on 10/19 after being rejected at the key psychological level of parity, but since then has become rangebound. At this juncture, it is unclear as to whether this will turn out to be a topping pattern, or a consolidation before making another attempt to blast through parity.

USDJPY – This has clearly been the weakest link amongst the majors. The close this past week was below the previous all-time low made back in 1995. Looking at the historical picture – the Dollar has been in a downtrend versus the Yen since the end of the Bretton Woods system back in 1971. As the weakest pair on the board  I would like to see selling pressure in the Yen accompany any broad based rally in the Dollar.


Bottom line: There aren't any distinctive set-ups before Wednesday, but afterwards the muddy waters should clear up, providing solid risk/reward opportunities going forward.


Stocks Overbought, November 3rd Is Looming

October 25, 2010 Leave a comment

Last week, I went over a few indicators pointing to a pullback in equities from a sentiment standpoint, but as I mentioned – an extreme in sentiment isn't in of itself a reason to buy or sell. A fundamental catalyst and/or the technical picture needs to confirm conclusions drawn from sentiment data. We may get both within the next two weeks.

This morning, the S&P 500 touched the 200 week SMA for the first time since June of 2008, however, it came close back in April – that turned out to be the sweet spot for sellers. The current set-up doesn't create a bearish case as compelling as the one in April, but when taking the 200 week into consideration with the level of bullishness and long-term technical support in the equity market's inverse ETF, the U.S. Dollar, it becomes quite evident that the risk for long positions is growing with each passing day. Also, the menacing posture of financial stocks, as evidenced by the SPDR ETF – XLF, provides further reason for concern.

      SPX touches 200 week SMA              Dollar Index (DXY) LT T-Line, Pessimism

Spx weekly          DOLLAR INDEX

On November 3rd, expectation, as everyone knows, is that the Fed could announce plans for more QE, and as such stocks look like they want to continue churning until then. This is beginning to look more and more like a classic buy the rumor, sell the news trade.

However, there does exist a bearish set-up, which if triggered could bring weakness to markets in the days to come. I am referring to a rising wedge on the 60 minute/multi-day chart, which sans the before mentioned FOMC meeting, I would feel more confident about.  But, since the market has been "geeked up" for several weeks now in anticipation of a move by the Fed, I am viewing this set-up with a cautious eye. The market is very close to triggering the underside trend-line of the wedge, and if it does the near term target is 1155-1160.

ES Futures – Multi-day Rising Wedge

Es rising wedge

FX Charts In The Spotlight – USDCHF, AUDUSD

October 22, 2010 Leave a comment

With the stage set for an explosive Dollar rally (Dismal sentiment + Long-term support). I am turning my attention to a couple of short-term charts which offer low risk set-ups. First, the USDCHF is breaking out of an inverse head-and-shoulders pattern. The near term projected price target is 0.9975-1.00.

              DOLLAR INDEX     Usdchf

The next chart is of the AUDUSD, where pent up volatility is taking the shape of a triangle and quickly closing in on a breakout. For now, if the pattern breaks the underside trend-line, the resulting move will be viewed as the C leg of a correction with a short-term target of 0.9550-0.9575.


GBPUSD – Keep An Eye On Trend Support

October 21, 2010 Leave a comment

GBPUSD (British Pound vs. Dollar) is currently testing its intermediate term trend-line extending back to the middle of May, after being rejected by a long term trend-line late last week.  There is a chance it could hold trend support, but given the potentially explosive situation brewing in the Dollar (everyone, and I mean everyone hates it click here, scroll down to U.S. Dollar Sentiment) coupled with the relative weakness in the Pound vs. other currencies ,  it seems unlikely.  My philosophy with trend-lines is this: 'Trust Until Broken". With that said, I will not be looking for lower prices until a confirmed break is in place, but to be certain – my trust in Sterling is on thin ice.


Sentiment In Equity Markets Flashing Signs Of Caution

October 21, 2010 Leave a comment

Earlier in the week, I highlighted the bullish extremes present across a wide spectrum of asset classes, and expressed my bearish tilt on certain FX pairs and precious metals. However, I only briefly touched on equities, and so it seems prudent given the current sentiment levels that I delve more into the situation brewing in equities.

Before getting started, I want to point out that simply identifying extremes in sentiment, in of itself, does not warrant a trade, at least not by the rules from which I operate. Sentiment indicators are powerful tools for identifying  price points where reversals are more likely to occur due to herding behavior. It provides the initial edge, but what sets the trade in motion is price action, by providing confirmation of trend saturation and reference points for assessing risk.

Sentiment Indicators In Focus:

AAII (American Association of Individual Investors) – Mom & Pop investors have been warming up to stocks quite a bit lately, in fact, so much so that the 4-week average of the AAII has extended towards the highest levels seen in half a decade.

Source: Sentimentrader

II (Investor's Intelligence – (or lack of))- Newsletter writers are also showing some love for equities, not to the degree as individual investors, but none the less they are still climbing aboard. This week the II Bull Ratio rose to an overbought reading of 67.1%, but still well shy of the 75%+ readings seen back in April and January.

Composite Model by Sentimentrader This model is a compilation of various indicators including sentiment surveys, Commitments of Traders data, put/call and open interest ratios, volatility indices, breadth ratios, TRIN, and several unpublished indicators, which Jason at Sentiment has under lock and key. As one can imagine, with all those inputs, it gives a pretty well rounded view of what is going on under the market's hood.

On 10/14 the reading for the Composite Model dropped to 23%, which is only the 11th time since the data began in 2000 that a reading fell below 25%. As you can see from the table below, when the indicator fell below 25% the market had a tendency to struggle in the next 2-4 weeks, and in a few instances much longer.

For this study, I outlined the number of days it took to reach a peak, which I defined as a price high proceeding a decline resulting in a close one month later that is lower than the peak price. The peak dates were also determined by looking at the first day the model pivoted higher after crossing below 25, which is consistent with mybelief that contrarian trades shouldn't be taken until there is a pause or shift in momentum. Furthermore, I also calculated the return of the market over a two week and one month period. 

If you throw out the three occurrences which occurred at the very beginning of the 2003-2007 cyclical bull market, the market folded in the near term 6 out of 7 times by an average of 3.4% vs. the one time the market rose by 2.1%. The reason I am discounting the 2003 occurrences is due to the extreme nature of sentiment and price at that time, similar to what the markets experienced in the spring of 2009. (Surprisingly, the monster recovery in early 2009 did not push this model below 25%.)

Also, take notice in regards to the amount of time it took for a price decline to materialize. In two instances the peak was 2-3 days prior to the turning point in the Composite model, and in 4 other instances the peak was seen inside of 9 days. This means that if the current extremes are indeed creating an inflection point, then the market should begin to experience weakness very soon.  (The turn date was Monday October 18th.)

  Composite Stats
source: Sentimentrader

U.S. Dollar Sentiment – The inverse correlation between the Dollar and Equities has been a considerable focal point for both technical and fundamental traders alike. The prospects of more QE has created a "what's good for risk assets is bad for the Dollar" mantra, and everyone is buying into it. The Daily Sentiment Index, as seen below, has recently registered pessimistic readings indicating that only 3% of traders are bullish, which is below levels seen in August just before a 4%+ rally ensued, and worse than the levels seen at the 2009 trough.

US dollar DSI sentiment Oct 2010
source: Elliot Wave International

The inverse correlation between the two assets has been extraordinarily strong, and like most correlations it will eventually experience a reversion, that time could be now. With that said, a reversal in the Dollar doesn't necessarily mean equities will also reverse, however; it does suggest some caution is warranted until the Dollar begins to make adjustments to correct the high level of pessimism.

Quick Glance At The Technicals:

Chart #1 – ES contract carving out a possible Reverse Symmetrical Triangle (RST), or a megaphone, depending on who you are talking to.

Chart #2 – EURUSD looks to be rolling over and forming the right shoulder of a H&S pattern.

                      Es megaphone
   Eurusd 240

In conclusion, equities, like other risk assets, look poised to retrace in the near term. I am not as keen on being short equities as I am on remaining bearish on Precious metals and certain FX pairs. On another note, the EURGBP triggered stops at 0.8830 – that's trading, moving on.


EURGBP – SHORT: Solid Risk/Reward Set-up

October 19, 2010 Leave a comment

The confluence of bearish technical factors present on multiple time-frames creates an excellent risk/reward opportunity in the EURGBP (Euro vs. Pound).

Here are the details:

1. Long-term trend-line extending back to the end of 2008 touches off on peaks formed  in 10/2009, 03/2010, and now.

2. Daily 14-period RSI has hovered above overbought for an extended period of time, and rolling over now as price stalls at trend-line resistance.

3. Head-and-shoulders pattern developing on the 240 minute chart.

EURGBP LONG TERM     Eurgbp 240

The projected price target, based off the range of the H&S pattern, is 0.8550-0.8600, to occur sometime in the next week.  An entry here at 0.8750 with a stop above the right shoulder pivot of 0.8823 provides this trade with a risk to reward ratio of better than 1:2.


October 18, 2010 Leave a comment

The reflation trade of the past several weeks has unquestionably taken its fair share of bears out to the proverbial wood-shed. The rally has been broad in nature as we experienced sharp rises in global equities – most notably in EMs, FX pairs, metals, treasuries, and recently energy joined the party as well.

The rally's synergy has pushed many of these markets to extremes proceeding pullbacks and/or consolidations. To say the least, it has been futile to be short any of these markets, but now from a short term standpoint, it doesn't look like a bad time to "get in the way" a little bit with stops closely at hand of course.

Sentiment has risen sharply. In the case of precious metals it has risen to a feverish pitch. Silver short-term sentiment, as measured by Daily Sentiment Index (DSI), has recently demonstrated on a few occasions that 95% of traders are loving the shiny metal.

Commitment of Traders reports (COT) show that large speculators have been piling into the futures markets, sending total position size in several markets into the upper levels of historical extremes.  Gold (255,874 contracts) and Crude Oil (129,326) are both sporting near record positions. The Euro Large Spec. position has made a complete round turn from the depths of a net short position reaching nearly 120,000 contracts back in June to a net long position of 41,511, which is just shy of the position size back towards the peak in late 2009.

Daily momentum indicators, such as the 14-period RSI, have become extremely stretched for an extended period of time.  I never rely on this indicator for stand alone signals, but my interest is piqued when the indicator stays in the nose bleed section for an extended period of time or begins diverging away from price. Silver 14-period RSI has been above the 70 line since the end of August, while the Euro has been above for nearly a month now. Both rarities, especially in the case of silver. (It should be noted, Silver can be a dangerous instrument to get in the way of given its history of really sticking it to the shorts before knifing lower.)

Recent price action suggest that we may see a price reversal very soon. The EURUSD closed below the prior days low for the first time since 9/7, or 28 days ago. I liked Friday's wide range reversal bar as a first entry, but upon taking a closer look (240 minute chart) one can see a possible head-and-shoulders pattern taking shape. The AUDUSD is flirting with a breach of a narrow channel extending back to late August. The GBPUSD has been the weakest of its foreign brethren and has rolled over more than 200 pips since Friday, where it failed to hold a breakout above the August high.

Gold and especially Silver have significantly expanded their daily trading ranges in the month of October. The 5-day ATR (Average True Range) for December Silver has increased 56% since 9/30. The speculative fervor is spooking the shorts, and drawing in the "Johnny-come-lately" crowd causing wild overnight and intra-day action. Often a sign that a sharp reversal is not too far around the corner.

In equities, I think the lagging nature of financial stocks will be tested. I have continued to wait for them to play "catch-up", but they have failed to do so yet. Should the stock market retrench a bit, it will be important for this sector not to fall apart if the market is to have a shot at heading higher later.

In after hours, Apple (AAPL) and Big Blue (IBM) are trading down over 5% and 3% respectively on the heels of earnings. This might be enough to spur some selling in the coming days, helping to bolster the "risk-off" trade and my near term bearish bias.

In the event that a retracement unfolds we will have to take another look at any technical damage done and assess whether we can continue to march higher into year end. The bull's case is for QE2 and lagging fund performance to keep markets trending higher. The bear's case is that QE2 is baked into the cake, and the myriad of structural issues and stalling in the economy will begin to weigh on investor's minds once again. At this juncture, I am still leaning towards markets staying propped up into year end.

Audusd daily


Eurusd 240