#$dollar

To trade or invest successfully, we have to think one step ahead of the market, but we have to discipline ourselves not to act early. We also must strike a balance between having a big picture perspective and being flexible as new information arrives–it helps to have a roadmap, but biases can be dangerous. The US Dollar has thrown some interesting curveballs recently, as an extended trend rolled over into a substantial pullback. Let’s look at some of the lessons this market has taught us recently.

First, this has been my roadmap for the past several weeks. This is a chart that was published in research sent to my clients  in which I outlined a plan for the next several weeks in the US Dollar. (Shameless plug here: I’m proud of the research product we produce and I would love to have you take a look at it. We offer of a free trial, and I schedule a phone call to speak personally and to discuss the research with anyone who takes that free trial.)

US Dollar chart with complex pullback plan, as of 3/27/15

At that point, I saw a few critical issues with the Dollar:

First, the trend is strong and intact. Looking for a reversal in the USD was (and still is) a sucker’s game. There is quite likely more upside in the Dollar.

We don’t have to anticipate the end of the Dollar’s trend; market structure and price will clearly signal that end when it comes.

However, this is an overextended trend and the first rally attempt was likely to fail1. Coming off of several months of “clean trending” currency trades, I was advising clients to expect the first rally in the Dollar to fail (it did) and not to buy into that rally.

Here’s how the trend developed a few weeks later:

Current US Dollar trend

So, the first rally attempt did fail, and any Dollar-motivated trades entered into that fake rally would have been losing trades. We were anticipating a deeper pullback, with potential into the low 90’s, but this did not happen. Now the question we need to ask is: is this “enough” of a pullback? Could the Dollar be ready to rally from this point?

The answer is unclear, so now it comes down to position management and trading skill. The one that that is clear, at least to me, that there’s more upside in the Dollar–tune out the anti-Dollar noise and focus on the message of market structure–but we have to be careful how we reach for that upside potential. The Dollar is at an inflection, and these points bring both danger and tremendous opportunity. The best way to play a market at an inflection is usually to take a position, but be quick to cut losses if the trade does not develop as expected, and this should be a pretty good plan for the Dollar over the next few weeks to months.

leading to a complex pullback ↩

[This post was originally published on SeeItMarket.com, here. I have added some comments at the end of the post to update following yesterday’s action. Despite the fact the market rallied instead of selling off, there are several points to consider in this post.]

For context: I’ve been bullish on stocks for many years and I’m still very bullish over the longer term (4+ months). However, there are a few factors that are aligning here to create some risks for stock market bulls. This is a story that might be best told in pictures, so here’s a ‘chart roll’ that captures the current S&P 500 chart setup.

Keep an eye on those minor tops

The latest upswing appears to be losing momentum and this makes the current S&P 500 chart setup a bit weaker.

Is that a bear flag pattern on the S&P 500 daily chart?

If we do indeed rollover, here’s a look at where the S&P 500 might be headed.

Today’s FOMC statement could be a catalyst that moves markets significantly. One of the key ways I phrase market moves for research clients is by laying out scenarios (we don’t know if this market will break up or break down today so we need to think about both) and appropriate actions for each of those scenarios (if it breaks down, due to these bearish factors, we do not want to be quick to buy weakness). This is not at all a call for a market crash, but it is a warning: buying the dip has been a trade that has worked well for many quarters, and we’d be reluctant to buy any dip today. There is maybe just a bit too much coiled bearish potential for comfort in the current S&P 500 chart setup. Longer-term, everything we see still points up, so there quite likely will be a spot to buy selloffs—just err on the side of caution today.

Update [the next day]: So the market rallied strongly, and nearly everything in the world saw a pretty volatile reversal from current trends, at least for a day. (Probably because most of the trades and markets we follow are heavily USD-influenced.) A few points to consider:

Even if you’d been looking for shorts, you should have had no entry trigger (if you are entering with short-term momentum), so no “damage” was done in this market rally.

Even though the pattern did not play out (yet), there is still great value in considering patterns like this from a risk management perspective–it’s good to know when to buy dips, and when it might not be a good idea. When you have a lot of coiled bearish potential in a market, it might not be a good idea.

Last, there “should have” been more followthrough. We are still within that bear flag. There is still downward potential there. It is interesting to see buying not lead to more buying; a pop like we saw yesterday generally has 2-3 days followthrough.

Bottom line: still plenty of room for caution in the short-term here, but the longer-term setup is strongly bullish for stocks.

We spend a lot of time, as traders, developing skills of precision trading: when to enter trades, where to put stops, when to add, when to take partial profits, when to get out and reenter. Most of the writing about trading, especially from technical or tactical perspectives, focuses on finding tools and patterns that tell us when to act. I think “doing nothing” is one of the key skills of trading, and it might be underappreciated by many traders.

False breakouts in a long consolidation in the Dollar

Take a look at the chart of the US Dollar index above. (One of the problems with the index basket is that it is so heavily weighted to the euro–a possible solution is to trade the EURUSD instead, but the concepts apply there, as well.) To put this daily chart in context, the Dollar had been on a historic trend run, was very overextended on weekly and monthly timeframes, and a pullback was probably overdue. But, with a trend this strong, we don’t think about fading the trend, rather, we look for places that the trend will resume following the pullback.

There were a number of false breakouts and false starts on this chart. I’ve marked two of them with 1) and 2), but there were probably others. What if you had entered long at either of those points? If you trade these patterns, you need to think about where and when you would’ve gotten out (or if you would’ve gotten out), and where your risk points for the trades were.

Timeframe is critical here. If you are a short-term daily or intraday trader, you pretty much have no choice but to get in and take some small losses on these trades. That’s certainly a valid plan, but just make sure you understand those small losses do add up. Especially when you are developing a trading plan, it’s easy to say “those are just tiny losses and I can keep looking for the big wins”, but, if you book multiple -0.3R (30% of the initial trade risk, a small loss by most measures) losses, for instance, they can add up pretty quickly.

For longer-term traders, the right thing to do is nothing. This is the message that I find myself reiterating time and time again in interviews, articles, and my published research for my clients. On one hand, it’s a pretty boring message: stay long stocks (which we’ve been saying for years), stay long the Dollar or short opposing currencies, etc’., but it’s also confirmation of and respect for bigger picture market structure. It is liberating to step back and say “I’m going to be hands off here and just let the trade work out”. Remember, too, there is such a large degree of random noise in markets, and micromanaging can easily lead to us getting lost in that noise.

It is certainly possible to trade within those longer term biases, but you just have to be clear on what kind of trader you are and what you will and will not do. If you find yourself nervous about entries and exits, consider backing off, focusing on the bigger picture, and giving your trades a little bit of space to move.