Did You Catch Explosion’s Advance Warning?

  • May 22, 2001
  • Marc Dupee

If you’re a trader, you’re looking for action. And one of
the best places to look for action is in markets that consolidate in tightening
ranges. Markets that have such “volatility contractions” invariably
make big, sometimes explosive moves as they overcompensate and revert to their
normal daily trading ranges. 

This is the situation that occurred in the
June dollar index
(
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PowerRating) and euro FX
(
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contracts with the dollar gaining 1.04% (tagging its contract high) while the
euro (which generally moves counterstep to the buck) tumbled to its lowest
level of the year. 

TradingMarkets Futures Indicators
6/100 Low Volatility
screen points out markets that have moved into low-volatility situations. The
6/100 List ferrets out contracts that have short-term (six-day) volatility
readings half or less that of their long-term (100-day) volatility readings.
Since volatility is mean reverting, explosive moves frequently occur after
contracts appear on the list. (Additional screens and proprietary volatility
indicators are available on TradingMarkets.com and in Larry Connors book Connors
on Advanced Trading Strategies, at TradersGalleria.com).

Spurring the currency moves was fresh data of economic slowing in Europe’s largest economy,
Germany. The move sent the
(
ECM1 |
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PowerRating) to its lowest level of the year in a steep
descent that continues a four-and-a-half-month down channel. Basis May closed
down .01170 at .86490.

Germany is pivotal in the European Community (EC) because
its economy accounts for one-third of the 12-nation euro-bloc’s gross domestic
product. Germany also consumes one-fifth of the Euroland’s exports. The
troubling data out today showed
that German business confidence fell to a nearly 22-month low. The German
economy is also expected to slow more than the rest of Europe with year 2001 GDP
forecast at +2.2% versus +2.8% for the rest of the EC. Orders for German
manufactured goods fell 3% in March and industrial production fell 2.8%. 

The evidence of economic slowing comes as pestering reports
of price growth appear likely to box in the European Central Bank’s leeway to continue stimulating
the economy by dropping interest rates (lowering interest rates can spark
inflation). Although the ECB recently stunned the market by cutting rates a
quarter point (and proving 28 of 29 economic prognosticators wrong), inflation reports out today from
Italy hint that the ECB will not be able to continue cutting rates. The recent
rate cuts also added to the impression that the ECB is behind the curve in knowing what is happening
with the European economy as the region moves to
within six months of circulating the single currency. 

The highly correlated Swiss franc
(
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tandem with the euro FX, losing .066 to .5661.

Since the euro is the currency most heavily weighted on the
dollar index, the decline in the euro ratcheted June dollar index futures
(
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PowerRating)
up 1.21 to a year-to-date high close of 117.79. 

June copper
(
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Sell setup, falling 1.15 to 78.65, but still failed to fill yesterday’s gap.  

August pork bellies
(
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PowerRating), a recent
Implosion-5 market, gapped lower but pulled back to provide entry at
yesterday’s low. The contract then continued its descent to make good on its
Pullback From Lows
setup, settling down 2.950, nearly their daily limit of 3.000, at 75.125. 

June lean hogs
(
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close out of its consolidation. Yesterday’s action is indicative of follow through in the
direction of the outside bar’s close: down. Hogs have traded straight down from
their opening tick and closed at a three-month low, down 1.125 at 66.375.

From the Implosion-5 List,
cotton
(
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PowerRating) continued its
brutal descent on favorable weather in the southeast. Cotton closed down .54 at
42.65.