30 Yr Bonds 07-22-2008

In yesterday’s blog, I laid the foundation for today’s analysis of the 30 Year Bonds. I am most comfortable with a trade when the price action for a secular (long-term) trend accords with the economic picture.

I have said this in earlier blogs, but it’s worth repeating: I subscribe to the Austrian School of Economics. Their basis is a simple but profound one: Humans Act; and because it is human action, we’re unlikely to be able to place economics in the same category as the physical sciences – i.e. we won’t be able to reduce economics to a set of formulae. It’s for this reason that I subscribe to the approach.

The assumptions I made in yesterday’s blog were:

  1. Because of massive increases in M3 since August 2007, we’ll see higher inflation numbers in 2009. I expect to see double digit inflation threaten as measured by the US CPI.
  2. Since the US economy is already weak, this turn of events can best be described as stagflation in the making.
  3. Under stagflation conditions, bond prices and stock prices can move in the same direction i.e. there is no flight to quality.

With that under our belt, let’s turn to the charts. Figure 1 shows the 12-Month (yearly trend), CSI Perpetual data.

07-22-2008-12m-us08.jpg

FIGURE 12-M 30-Year Bonds CSI Perpetual

The 30Yr bottomed in 1981; from 1981 to date, we have seen a 28-Yr bull market. But, the inability of the market to get to the top of the channel since May 2004 suggests that the turn down from January 2008 will mark the beginning of a bear phase. Note that this is an unproven statement. After all, the market could turn north and hit the top of the channel. But given the assumptions yesterday, and the position of the 13-Week (quarterly trend), I rate the move North as an unlikely event.

Figure 2 shows the 13-W position (quarterly trend).

07-22-2008-13-w-us08.jpg

Figure 2 13-W US Bonds, CSI Perpetual

Figures 2 & 3 show a number of behavioural parameters:

In Figure 2, we have acceptance below the top of the Value Area, 118.90. The 80% Rule states we should see the market go to the bottom of value, 109.9 before we see re-acceptance above the top of value. If the down move is to stall, it will most likely stall at the Point of Control, 113.75. So, any shorts instituted above Value, will have exposure i.e. the worst that can happen is a scratch trade.

Figure 3 shows:

The Ray Wave Count on the 18-D (monthly trend). We see a Running Correction at Wave 2. One close above 117.52 would be a warning the move is aborting. So we can center exit strategies around this price.

There are two areas where the move may abort:

  1. The confluence of 100% of the H&S and one of the First Wave price zones, 108.34. Note that this is below the bottom of Value. Once we have acceptance below the bottom of value, Market Profile Theory suggests the market should move to the 13-W Primary Buy Zone, 105.82 to 103.36.
  2. The confluence of a First Wave Price Zone and the minimum target for Wave 3 where Wave 2 is a running correction, 104.63 to 105.06. Note that this price area is within the 13-W Primary Buy Zone.

07-22-2008-18-d-us08.jpg
FIGURE 3 18-D Ray Wave Count 30-Year Bonds, CSI Perpetual
The statistical targets are not relevant at the moment. The normal 13-W impulse move runs for 26 to 52 weeks and for a move of 25.33% to 17.17%, I’d consider them after (and if) the 30-Year Bonds move to the 13-w Primary Buy Zone.

One last point. Last night’s price action shows that the majority of trades in the 30-Year still seem to be tied to the idea “S&P down, Bond Prices up”. We will need a number of high CPI to break the ‘flight to quality nexus’. So, it’s important to pick your spots to enter under these conditions.

Summarising this blog, I’d like you to notice:

  1. I explicitly set out my assumptions. This makes it easier to identify where a trade has gone right or wrong.
  2. I treat chart patterns as behavioural parameters i.e.they can fail. So, it’s important to identify the price zones and conditions under which I believe they are failing. These form my exit strategies.
  3. I identify my target areas for profitable exit. With the information, I’ll calculate my Risk: Reward. In addition, the targets play a part in my position sizing

From the questions I have been receiving, it’s clear you are using the blog as a trade advisory service. Not a great idea,folks. One of the reasons why 80% to 90% of newbies fail even though there are quite a few great services is because:

  • a ) The time frame may not suit the subscriber
  • b) The stop risk exposure (stop levels) may not suit
  • c) Most importantly in my case, I am not providing position sizing and trade management information – info that is critical to your success.

If this blog is to provide a public service, it is as a coaching tool. It’s best you treat this as that.

An Overview of Markets

First off, thanks, Ana, for helping out on Friday – I was trying to do too much too soon and paid the price.

I was going to examine the 30 Yr Bonds today – but I think a better approach is to lay the foundation for the comments.

In my trading, I look for an idea that places the secular trends in context. Markets have certain relationships that hold true but the relationships differ according to the context in which they occur. The current context is rare and I’d like to examine that next.

The current economic state has brought about bubbles in the stock and housing markets that led to the sub-prime crisis.

What would have been a reasonably short recession now has all the earmarks of a longer term down-term or hyperinflation ; hyperinflation will occur if the Fed fails to act once the results of its actions, since August 2007, filters into the inflation figures. If hyperinflation does not occur, the US, at the very least, will suffer a period of stagflation.

In the meantime, the other economic engine, China, is already suffering rampant inflation, and unless the Chinese authorities take more aggressive actions to cage and curb that tiger, it too will have to deal with hyperinflation.

If both the US and China suffer an economic downturn at the same time, then the rest of the world will catch more than a cold.

In this environment, what can we expect?

  • A strong secular uptrend in commodities – Soybeans, Gold, Wheat etc. This does not mean we won’t have corrections e.g. Crude and Soybeans are in the throes of one now. But it does mean that the commodity boom will continue until the threat of hyperinflation is negated.
  • The start of a new uptrend in interest rate yields (downtrend in price).
  • Global tensions that will add to a strong secular uptrend in Gold and Silver. Again I do not expect a straight line advance. Right now for example, I see Gold forming a sideways market between $1045 and $850.
  • A bear market in the stock indices. In the S&P, we are currently forming either a simple correction or a sideways market between 1256 to 1280 and 1200. We’ll have a better idea of the type of correction when we see a retest of the 1200 to 1210 area.
  • The bear market in the US$ to continue. We can expect a bear market rally once the CPI starts in earnest to rise; that rally will terminate once it becomes clear that hyperinflation is a real threat to the US economy.

These are rare conditions: a current stagflation with the overhanging threat of hype inflation. In addition, we can expect even greater volatility because of the actions of politicians, who failing to understand the cause of the crisis, will look for scapegoats. What better candidates than ‘greedy’ speculators? In their attempts to ‘fix’ the problem, their actions will further disrupt the markets and will cause even greater volatility in price action.

As traders we can expect:

  1. the secular trends in commodities to continue but need to be careful of political action: for example, some sort of bill to restrict the number of contracts we can hold in Crude Oil.
  2. the secular trend in gold to continue
  3. a particular strong secular trend to begin in 10-Yr Notes and 30-yr Bonds.
  4. the stock market bear to begin in earnest.

Correlations

I am flying to Singapore today so I am posting Thursday’s blog early morning Hong Kong time.

Yesterday I received two e-mails asking: “since you believe that Crude Oil is going to go down, won’t this mean the S&P will go up?”

The questions imply that there is a negative correlation between Crude and the US Stock Market i.e. if Crude goes down, the Stock Market will go up.

I ran some correlation studies; in fact the correlation between Crude Oil and the S&P is meaningful (90%) only in 2008. The farther back we go, the lower the correlation becomes. For correlations to be robust I like to see 90% over at least 15 years of data. Even in 2007, the correlation was less than robust.

Figure 1 is an example of what I mean.

07-16-2008-qm-correlation-sp.jpg

FIGURE 1 Correlation Crude Oil and S&P

We start at the 13-week (quarterly trend) S&P swing low. (Note I have not shown the Barros Swings for the sake of clarity). The Crude Oil 13-w swing low occurred earlier on January 18 2007.

Both markets went up until the S&P peak on July 16 2007. The S&P corrected down while Crude continued up until August 01 2007. The correction for the S&P ended on August 16 2007, while the correction for Crude ended on August 22. From August 22, both markets turned up until an S&P high occurred on October 11 2007.

The example is meant as an example to illustrate the correlation studies I did; it is not meant as evidence of a lack of correlation – the correlation studies do that.

The point is, be careful of “Wall Street Lore”. Sometimes the story has some merit; at other times, the story has no merit and at still other times, the current situation is an exception to the story. Speaking of exceptions, let’s turn to one.

“Bonds and stocks don’t move down together “.

The reason for this is when the stock market moves down, there is a flight to quality to Bonds that drives prices up (yields down).

Correlation studies show this is generally true. But, there is one exception: in periods of stagflation, Bond prices and the Stock Market can run in the same direction. For example, in 1972 to 1974, Bond prices went down (yields up from 5.73% to 8.70%) and the stock market also went down 38%. The critical question, therefore, is whether the US economy is set for a stagflation period.

I believe it is.

At the very best, the US economy can be said to be in slow-down mode. I say this to avoid getting embroiled in a discussion on whether or not the current state satisfies the technical definition of a recession. As Shadow Stats (http://www.shadowstats.com) points out:

“… real (inflation-adjusted) second quarter retail sales contracted for the fourth consecutive quarter, while the second-quarter industrial production showed a sharp quarterly contraction. In conjunction with consecutive quarterly contractions in payroll employments, these numbers should remove any doubt of the economy being in recession.”

Yesterday (CPI) and Tuesday (PPI), we saw the effects of the recent FED/Treasury bailouts seep into the inflation numbers. Shadow Stats tracks M3 growth and it shows a massive increase since August 2007; M3 peaked at a massive +17%. It currently stands at 16%.

Given what Bernanke said at his testimony on Tuesday and Wednesday, we can expect new liquidity moves – these will increase M3 even further. Based on this, Blind Freddy would see that the CPI will probably be reporting double-digit inflation in 2009.

I write this to lay the foundation for a possible long-term top in the 30-year Bonds. More on this tomorrow.

Soybeans July 16 2008

Before I get into today’s blog, a short detour to comment on Ana’s contribution:

The SEC has passed an emergency rule to limit short selling in certain types of institutions. Hmm, the thin edge of the wedge? Steve Briese recently placed a warning on his site that I posted on “S&P 06-30-2008“. Speculators are being blamed for the short-sighted policies of the Bernanke FED and the Bush administration. What’s frightening is this could be  the first step in this direction. The next targets could well be the evil-doers who have pushed up Crude Oil prices! It would not surprise me to see some move in that area. Be warned!

Off my soap box and onto the Soybeans. In this blog. the data  used for my charts is CSI’s Perpetual Contract. The ideas expressed here are contained in the Nature of Trends except for the references to Seasonal Patterns and COT data.

Figure 1 shows the 12-month swing (12-M; yearly trend).

07-16-2008-12m-s.jpg

Figure 1 12-M Soybeans CSI Perpetual

Notice that the current increase of 225% is second only to that of the 1974 increase. In addition,the stats from Gann Global data confirm the view derived from Figure 1: we are at an extreme price (i.e. mean + 3 stdev) where theoretically, there is less than a 1% chance of the 12-M swing line continuing up.

Figure 2 shows the 13-week swing (13-W; quarterly trend).

07-16-2008-13w-s.jpg

 

Figure 2 13-W Soybeans CSI Perpetual

Notice that we have a potential Upthrust Change in Trend pattern. We need to see a weekly close below 1486 that exhibits selling conviction to confirm the13-W Change in Trend.

The ancillary tools I use are also supportive of a short. Seasonal highs occur at this time and bottom end September. In addition the COT studies show  noticeably reduced trader interest than that shown at the March high, making a continuation of the up move unlikely. These indicators increase the probability of a short moving to at least Figure 2’s Primary Buy Zone (1086 to 1143, basis Perpetual Contract).

Figure 3 shows the bars that I entered the trade. I was happy to enter on the basis of a potential 3-d Head & Shoulders Pattern and more importantly because:

  1. A DOJI formed on Friday July 11 2008
  2. The market on July 14 formed an ‘Open-Gap’ down that was not filled on the 1st hour. (Bearish sign)
  3. The bear bar of July 14 prompted the entry on July 15 when the market accepted prices below the low of July 12.

Stops are above the July highs. My reward to risk ratio is 6:1. (Yes I did pre-empt the 13-W Change in Trend signal. I’ll do this where the short-term patterns support early entry, as in this case).

07-16-2008-18-d.jpg

Figure 3 18-d Soybeans CSI Perpetual

Crude Oil – Wither now?

I wanted to review Crude Oil (this blog) and Soybeans (next one), the two hot commodities.

In the case of Crude Oil, let me say I am indebted to Gann Global (http://www.gannglobal.com/gateway.php) . I have a reasonable data base but it is nothing compared to Gann Global’s. I subscribe to their services because of the raw information they provide.

If we look at a Crude Oil chart since inception, we go back to 1983. Let’s say I want to calculate a mean impulse move in the 12-Month swing (yearly trend), Figure 1 shows that a 5-year low took place in February 1999 and since that low we have had 2 measurable impulse swings – hardly an adequate sample.

07-15-2008-crude-oil-12m.jpg

FIGURE 1 12-M Crude Oil

The reason I want to calculate the stats? The move since January 2007 looks like a blow-off wave. I want to know if it is still high risk to contemplate an entry at these levels. You will recall I had posted a blog explaining why I had exited all longs at around 137.00

Gann Global came to my rescue – they provided the information I required. The approach they took was to measure the equivalent of the 60-month swing for all commodities and came up with a sample size of 67. Based on Pete Steidlmayer’s method of calculating the stats, mean +1 standard deviation came in at ‘290% increase to 729%’; ‘mean +2 came in at 728% to 1020%’; ‘mean +3’ came in at 1021% and higher. Since the start of the 60-M swing, February 1999, the increase has been 1092%, in the mean +3 category.

Theoretically, therefore, Crude Oil has less than 1% chance of continuing its upward climb. On this alone, I would say that to enter now would be a high risk entry. In addition, since it made a high on June 6 2008 at about 139 (basis CSI’s Perpetual Contract), Crude has been struggling to move higher. Finally, we can’t get away from Crude in the news; it’s everywhere: TV, magazines, papers etc.

There is another point I’d like to mention, because this is a blow-off wave, I expect the market to break sharply once the high is hit. Figure 2 shows the type of price action I mean.

07-15-2008-12m-soybeans.jpg

FIGURE 2 Soybeans 12-M

This is not a recommendation to go short. There is no pattern to suggest a change in trend is imminent. Before going short, I would need to see an 18-d Lagging Change in Trend or at least a 5-d Forecasting Pattern (see Nature of Trends). However, given the maturity of the 60-month uptrend, now is not the time to rejoin the fray.

By the way, as an observation of my own trading, I tend to exit at the end of a secular trend 3 to 9 months too early. In the US stock market, I exited all positions in July 1999; the final top in the S&P did not occur till March 2000. I tend to misjudge the madness of crowds. As Lord Maynard Keynes once said: “The markets can remain irrational longer than you can remain solvent”.

So, don’t go shorting Crude Oil, at least not yet. If long, make sure your stops are in!

IndyMac Update & Scenario Creation

I was going to write on the bull markets of Crude Oil, Soybeans and Gold today; but I have decided to follow-up on the IndyMac failure and use it as an example in scenario creation. The link below leads to the video with the example. Below that are a number of observations on the IndyMac story.

http://www.tradingsuccess.com/video/blog-071308/indy.html

OBSERVATIONS:

  1. The IndyMac stock price had dropped from a high of US$45.46 on May 5 2006 to Friday’s open of US$0.21. It closed at US$0.28 and after the story broke, the market is said to have dropped to US$0.03. The fact that the stock price had dropped to below US$1.00 on Friday’s open illustrates that IndyMac’s troubles were well known.
  2. That being the case, you could argue we may not see a reaction. But I don’t see it that way. Indy is a large bank and its failure is another hot coal in the fire of the troubled US financials. Following on the heels of Freddy and Fannie, it will lead to an adverse effect on the US Stock Market.
  3. I looked at equivalent bank failures from 1966 to the present and 1900 to 1926. There were 8 in all. All had a similar effect of :
  • leading to at least a 4% to 5% rally and
  • On the day after the news hit the market, whether or not that day had a down close, we saw an up close in the Dow Jones. So, if the pattern is to repeat, then Tuesday should be an up close.
  • A sample of ‘8’ is not large enough to be robust but it does provide some data to create preliminary scenarios, scenarios that will be confirmed or rejected by the price on Monday after 9:30 am EST.

07-13-2008-indymac-m.jpg
FIGURE 1 IndyMac Monthly Chart

IndyMac – Bank Failure Atlanta

I don’t normally post on weekends. But in this case the news warrants it.

At 6:00 PM Friday, the FDIC announced the closing of the US major bank, IndyMac and the transfer of its assets to a new bank. No one will lose money but the closure may affect two other lending institutions in Atlanta.

The news should impact Gold, the US$ and the Stock Market.

US STOCK MARKET

I expect the news to have an impact on the trading in pre-US session on Monday. According to charts sent to me by Sentiment Trader (SI), previous bank failures marked the start of a rally. In some case we first had a large day down that was followed by a bear market rally (or the bank failure marked the end of correction and the resumption of the uptrend); on other occasions, we had key reversal days.

Given the abovementioned SI report, selling at the open of the US session may not be the wisest thing to do. It will be Tuesday that will be important. In every case, we had a rally after the news day. So if we don’t get the rally on Tuesday, we’ll know something is different this time.

US DOLLAR

The news should send the dollar south.

I am interested to see if the EURUSD will result in a strong breakout. At the last attempt, the breakout above 160 was anemic and the US$ rallied. Let’s see if we have a confirmed breakout this time.

The other currency I like is the AUDUSD. The AUDUSD broke up on Friday July 11. I expect to see a continuation on Monday. A close below .9600 will negate a bullish scenario.

GOLD

For reasons stated in the blog to come on Monday, I am of two minds about the current Gold rally. In any event, for Monday at least, we should see Gold up, at least in the early part of US trading.

I am attaching two reports of the failure. One is the statement by FDIC; the other is a news report commenting on the closure’s effects.

feds-shuts-down-indymac-bank-two-atl-centers-impacted-atla.pdf

ots-closes-indymac-bank-and-transfers-operations-to-fdic.pdf

More information can be found at Ana Wang’s site: http://awanginvest.com/?p=555

S&P 07-10-2008

Yesterday I said that Tuesday, July 8, had generated a buy signal. Let’s take a look at that analysis.

Figure 1 is the 12-period swing on a monthly chart (yearly trend).

07-10-2008-12m-sp.jpg

FIGURE 1 12-M S&P (CASH)

We see an Upthrust Change in Trend from up to down. The sell signal triggered in June when we saw a directional bar down. June’s bar negated the buying extremes of April and May. If July closes below 1291, then we should see prices move down to the bottom of value at 1030. If the Upthrust is to fail, it will most likely fail at the 50% area 1160 to 1161. By fail I mean the market will turn at that zone and resume the uptrend.

Figure 2 shows the 13-period swing on a weekly chart (quarterly trend).

07-10-2008-13w-sp.jpg

FIGURE 2 13-W S&P (CASH)

Figure 2 shows that:

  • the 13-W as yet had not given a Whole Point Count (WPC). However since the 12 line has turned down, I expect the 13-w to provide the WPC in the next 2 weeks.
  • You’ll note the price at 1458.87 – this is the price at which the 13-w will turn up this week. This price will continue to fall in the coming weeks. Should the 13-w line turn up, we can expect an 18-d trend change to be signaled.
  • The 13-W is signaling a possible Negative Development Buy signal. It is not a Spring but the signal was not preceded by a downtrend. In this context, the buy signal would suggest a 13-W sideways market between 1404 and 1256.

Let’s turn to the 18-period swing on a Daily chart (Monthly Trend)

07-10-2008-sp-18d.jpg

FIGURE 3 18-d S&P (CASH)

In Figure 3, the 18-d Barros Swings have been obscured by the 60-day Hart Swings (i.e. the quarterly trend is so strong it is dampening separate 18-day swings). The blue rectangles mark areas where we have seen strong responsive buying. This is a bullish sign because the 1255 to 1240 area are new lows in a 5-month period but the market has been unable to definitely break down.

A close above 1280 with buying conviction would provide a Negative Development Buy signal. Since this would mark a 13-W line turn as an 18-d trader, I’d take the trade. However, because the 12-M has just confirmed a sell signal and at best the buy would mark a 13-W , we’d be looking at stops below 1220 (i.e. below the maximum extension) but this is too wide a stop. Anther stop I’d try in this case is below 10% of the range 1280 to 1240 (current low) below 1240. This would give a stop around 1234: 46 points still too big.

Hence if I were to take the trade, I’d have to enter intra-day. Figure 4 shows the Market Profile on July 8.

07-10-2008-sp-mktpro.jpg

FIGURE 4 S&P MARKET PROFILE

The blue rectangle shows the area I would have sought to enter my longs, around 1262 to 1265. This would represent around a 30 point risk (stop 1234), something just acceptable.

The rationale for the buy was this: The market auctioned down to the Primary Buy Zone of July 7 and found support. If the market was going to form a low, we could expect a 30 point range. An order on stop above July 8 ‘G’ period high could secure a buy late in the day extension.

The market accommodated the scenario. But note that the buy was not confirmed. On July 8 we had a strong day up on solid volume but had not closed above 1280. To confirm the trade, we needed to see continuation on July 9. We see in figure 4 that on July 9, the market opened and rotated in the early part of the day. This development would have caused me to raise my stops to just under the 50% area of the Profile of July 8 (area marked in red). When the market broke during the ‘K’ period, I’d have lost 1 to 4 points.

Note I have said ‘would have’ throughout the blog because my health prevented me from taking the trade.

What now?

Figure 5 shows the 80-minute S&P with 18-period swings (red lines). It also shows my preferred Ray Wave Count with a running correction at minor structure 4. (The filled numbers represent the minor structure). This is not an ideal running correction because of the strong corrective up waves (marked in red rectangles). But the price action of July 9 is characteristic of the end of the correction.

If the running correction scenario is correct, we can expect another down today. I’d expect to see either a directional bar down or a bear-bar (see Nature of Trends).

07-10-2008-sp-80m.jpg

FIGURE 5 S&P 80-Minute

S&P 06-30-2008

Hi All! It’s great to be back if only for one issue this week. Next week, I’ll be back back to writing Monday to Friday.

Before I look at the ES, I want to thank all who dropped me a ‘get well note’. As soon as I can sit for more than 20 minutes at a time, I’ll reply to each of you individually.

Secondly, I want to thank Ana Wang for doing a sterling job while I was away. Just four more days,  Ana, and you’ll be off the hook. Thanks too to all who have assisted Ana with contributions.

Thirdly, I subscribe to Steve Briese’s ‘Commitment of Traders’ newsletter. There is a timely warning at

http://CommitmentsOfTraders.ORG/?p=37. I recommend you have a quick read of this post.

 

Let’s turn to the ES.

 

Friday’s price action is a warning to the Bears not to become complacent. Let’s see why.

 

The current trend is a sideways market. Figure 1 shows (all figures basis cash):

  1. The boundaries of congestion: 1440 to 1256

  2. The Value Area: 1399 to 1318

  3. The Primary Buy Zone: 1258 to 1281

  4. The Primary Sell Zone: 1440 to 1418

  5. Friday’s Bar Range of 17.45 was at the lower end of normal BUT its volume was at the higher end of normal. This is a Negative Development Buy Signal (see Nature of Trends).

Given Friday’s small range/large volume day, the market is warning of a possible rally. This is one side of the picture. On the flip side, notice that the average daily volume on the way down has been around 457,000. I’d have been more comfortable buying if this volume would have been less than that. In this congestion, volume of this magnitude has resulted in breach of the previous lows (on 01/23/08 and 03/17/08).

So how would I handle this situation? Recall that I trade the 18-d and it has signaled the probability of a down trend:

  • An Upthrust Change in Trend affirmed by the Whole Point Count (WPC) and other filters.

  • What is missing to confirm the down trend is a series of lower lows and lower highs.

So I would not initiate long positions until the downtrend signals are invalidated. But, if short, I would take profits on some of the positions. I’d also be on the lookout for how the market behaves on a breach of 1256. If the market shows signs of facilitating trade to the downside, I’d look for a place to initiate some new shorts.

 

06-30-2008-es-vol.jpg

FIGURE 1 S&P Cash

Collapse in market volatility

 

 

Market Volatility and its collapse

Cross ref: www.awanginvest.com

A NUGGET OF TRADING WISDOM TO SHARE WITH YOU:

Fig: SP500 Daily that is close to a collapse in volatility of price bars, (in rectangle) leading to strong down move

What is market volatility?

Volatility is a measure of dispersion around the mean or average return of a security. One way to measure volatility is by using the standard deviation which tells you how tightly the price of a stock is grouped around the mean or moving average (MA). When the prices are bunched together, the standard deviation is small. When the price is spread apart, you have a relatively large standard deviation.

Another way to measure volatility is to take the average range for each period, from the low price value to the high price value. This range is then expressed as a percentage of the beginning of the period. Larger movements in price creating a higher price range result in higher volatility. Lower price ranges result in lower volatility.

The stock market is a volatile place to invest money. The daily, quarterly and annual moves can be dramatic, but it is this VOLATILITY that also generates market returns.

Market Performance and Volatility
There is a strong relationship between volatility and market performance. Volatility tends to decline as the stock market rises and increase as the stock market falls. When volatility increases, risk increases and returns decrease. Risk is represented by the dispersion of returns around the mean. The greater the dispersion of returns around the mean, the larger the drop in the compound return.

Market behaviour is predictable to a degree, but no one can predict what a specific market will do at a precise time. The market business is not one of predictions but one of probabilities. As one TV ad rightly declared: If you want a fortune-teller, the place to go is to the circus.

When we have enough experience, we will know that price history repeats itself. From price history, one can extrapolate predictable patterns of price behaviour because they are fractals as I mentioned in an earlier post about the Golden Mean and fractals occurring in markets as well.

Having said this, there is a pattern which I recall that my mentor Ray Barros has once pointed out to me to watch out for. It is the pattern known as a ‘collapse in volatility’. This collapse in market price volatility occurs when trading ranges narrow substantially, so that the price chart bars of whatever time frames suddenly get smaller. These price bars should be at least three in a row and do not need to get progressively smaller in each bar.

However, we should not confuse a collapse in volatility with a trading range or congestion or sideways pattern. A trading range has some support or resistance levels, which are also longer in duration than a collapse in volatility. The bars are also not so narrow.

What happens next is a probable trigger of a significantly bigger price move – which could be up or down. Sometimes, the use of additional technical indicators may help us see which direction the market is likely to go.

Suffice for me to say, when you observe such a collapse in volatility in price movements in a chart of any time frame, be forewarned of a bigger price move to come, which could either go north or south.

ANA aka IDKIT

Ag Moderator