How To Fade A Gap
Ah yes, post-Labor Day
trading, no other time for traders offers so much potential. The
summer is behind us (good riddance) and the market must now come to terms with
the improving fundamentals (debatable, some would say), the trading range and
just how much has been priced in already. One thing is for sure, the trading
can only get better. Nonetheless, I was able to navigate the summer trading
range and post profits. If I can do it then, a marginal pick-up in volatility
will have a big impact on the bottom line. While one should not expect an
immediate resolution once the bell rings, I suspect that subtle and
not-so-subtle clues will be revealed. The path of least resistance seems
higher, however, that is what sets up the potential for just the opposite.
However, take a look at the chart below, not only
has Average True Range (ATR) collapsed (not atypical for the summer, but
it is also in a long-term downtrend as well) but the market is still unable to
take out the highs set in June. In fact, only the early August thrust bested
the previous test at the June highs. I frankly think the technicals look weak,
but this is no time to be drawing lines in the sand — a momentum-driven market
can be dangerous when it comes to making predictions.
My plan going into today’s session is to be on
the lookout for potential opening reversals. Remember to keep in mind the basic
characteristics of a Fade The Gap trade:
1. Thrust well outside Bollinger Band on 1 and
5-minute chart
2. A corresponding thrust in the S&P futures
3. Confirmation from stochastic of potential
reversal
These types of trades frequently occur on Monday
mornings, (Tuesday for today) as well at inflection points. This being the
beginning of the home stretch for the year may simply magnify these trades.Â
There is simply too much optimism baked into the market, any little curve ball
will allow the professionals to come in and catch everyone flat-footed. With
bonds under decent pressure this morning, they bear watching. Thus far the
equity markets have disregarded the bond market rout; at some point though,
bonds may matter.
A reader recently asked me about my rationale on
entry and exit regarding the recent short in EUR/JPY.Â
First off, no this is not a radical departure from my normal format,
HVT, but I will continue to share these
types of trades/observations with you as a way to broaden the scope of the daily
commentary. You will notice fairly quickly that much of my longer term analysis
is based on fundamentals, coupled with confirmation from technical analysis.Â
For me, this is a matter of preference, given my typical short-term (extremely)
holding period I need more than simply a moving average or chart pattern to
provide conviction if the trade will last several days or weeks. Ultimately
fundamentals play out, charts allow you to hopefully time you decisions more
effectively. Bottom line: A “story” (fundamentals) is something I can hang my
hat on and it provides conviction; long-term I do not get that same conviction
from technical analysis alone.
The rationale for the short EUR/JPY trade was
ultimately based on fundamentals. Consider the following, it pens a compelling
story:
1. Europe’s seemingly sluggish economy
(recession again in France and Germany) while the US, and Japan in particular,
are showing continued signs of life does not bode well.Â
2. The demographics and entrenched union
mentality will not allow for reforms which are required in order to turn the
mess around.Â
3. The strong Euro (EUR) has had a negative
impact on exports. Meanwhile massive Bank of Japan (BOJ) intervention in the
Yen to keep it weak (relative to importing nations) has propelled exports.
4. The ECB’s (European Central Bank) reluctance
to cut interest rates has slowed prospects of a recovery.
5. Industrial Production in Japan is on the rise
as is Business Sentiment.
6. The ECB predicts growth of only 0.7% versus
the OECD forecast of 1% growth in Japan.
7. Labor costs in Europe are simply not
competitive, given the rising dominance of China and India as low cost producers
— the writing is on the wall.
While this trade was originally intended to be
long-term as this course of events seems likely to play out for some time, the
markets immediate confirmation provided a rare opportunity to capture what I
would consider outsized profits relative to the time frame. Ultimately I will
get back in the trade, but for now, the charts, not the fundamentals, dictate
remaining on the sidelines and seeking a better re-entry.
| Support/Resistance Numbers for S&P and Nasdaq Futures |
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As always, feel free to send me your comments and
questions.