The Rogue Wave

As this is being written, the US equity markets have opened sharply lower following the action of the  Asian market sell off. Late Friday afternoon, OPEC had essentially announced that their cartel has fractured and that oil prices would no longer be controlled at managed levels via production controls.   Couple this with the on-going panic caused by the corona virus scare and a black swan type event is occurring in the markets worldwide.  It’s as if a rogue wave had broadsided the markets.

The consequence of all of this news is that global markets are reeling in the realization that much of the known landscape has changed, seemingly overnight. All of sudden the market has become Game Of Thrones.  Traders have been overwhelmed by forces beyond what their modelling accounted for and now are scrambling to adjust to new market forces.  Market professionals who have only observed up markets for their entire careers are suddenly faced with severe dislocation of assumptions.  Interest rates, oil prices, supply chains, demand for goods will all have to be re-modelled to reflect the sea change.  Professionals are in disarray, markets are in a high volatility state and panic is reflected by massive selling.

This is a time of great opportunity.

How do we know if everything has changed? Has the long 10 year plus uptrend in the stock markets ended?  Here is a long term view of the SPY ETF showing the path of the markets over a long time period.

2020-03-09 (4)

While the recent sell-off has been severe, the overall trend remains within a strong upward trend. We can observe that there have been other sharp corrections, notably the October/November period of just last year.  That selloff did not have the accompanying wave of ‘bad’ news that we are experiencing today and subsequently, markets rose again.  To be clear, trends do change, but until there’s an objective measure of a trend change, emotional responses can occur at the worst times.  What we can observe based on the recent market action is that momentum indicators did diverge from the new highs posted just barely a month ago.

It should be emphasized again that markets collectively move based on information that’s known to markets as well as anticipation of information not yet known.  Shock events cannot be predicted.  The challenge for traders is to gauge the response to these events by other market participants.  Part of the reason that severe swings can occur during times of market panic is because so much activity is the result of the concentration of money in large institutional hands: banks, ETF companies, mutual funds and sovereign wealth funds.  Because of the interdependency of many of these entities, their collective actions will exaggerate any market volatility and thus mispricing will occur.   This point requires emphasizing.  Technical analysis measures the responses of market participants, not the value of the market. 

Markets will always swing from optimism to pessimism and back again.  Trends once established are key barometers and should be the compass guiding trading and investment.   If trends decisively change, our trading tactics and strategies must also adapt. Our next commentary will focus on which asset groups look likely to rebound first.  In the meantime, we look for the same things we’ve discussed at length in previous commentaries including declining downside momentum, key reversal bars, volume climaxes and relative strength comparisons.  We are using these as proxies for change in the sentiment of traders.



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