It Ain’t a Trend Until it’s a Trend

The euro and the dollar both looked ripe for countertrend rallies. Still do, actually. In my last post, I shared some charts that showed what I thought were very good set-ups for what at least could be some short-term trend reversals in the two currencies. This was of course well before the monetary nuke dropped by the Swiss National Bank that they would no longer be pegging the franc to the euro. Subsequent to this announcement, the franc took off like a rocket and the euro has dived well past support.

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The rocket launch of the franc has seen plenty of banks, forex shops, hedge funds, and various financial institutions cumulatively lose billions of dollars; and the total damage has yet to be seen from all the short franc trades around the world. Those who may have positioned early on the euro or dollar reversals would almost assuredly have been stopped out. I was fortunate to not have taken a position in either currency. Specifically, I stated on January 5th, “I have not positioned in a trade yet as I haven’t observed a very usable signal just yet, but we are very close.”

Adhering to the discipline of waiting for confirmation from my go-to signals versus taking a chance on the price action based on trend lines saved me from a loss; even if the loss only would have been minimal due to stop-discipline. The same thing could be achieved by simply waiting for the price action to confirm the trend reversals. One notion that many of the best traders consistently follow is simply letting go of trying to time 100% of a move. There is enough profit made by catching 80% of a move by letting a trend establish itself. This concept is age-old and time-tested.

I prefer the indicators in conjunction with the price action, but if you’re going to be trading then you should have a methodology or technique that allows you to safely enter into a trade. You shouldn’t be throwing money around willy nilly simply off of squiggly lines and 100 year old patterns. The indicators I like to follow are very common and used by virtually everyone, however, I have specific chart timing I like to utilize. Additionally, I have a subtle difference of viewing the indicators for confirming signals. For the indicators I like to follow, most traders are still using crossovers but that simply doesn’t work anymore due to the mainframe warehouses being able to program out their market efficacy. This is my edge. It’s been backtested over several years and many trades. It’s not some guaranteed profit magic item I consult before each trade. I get stopped out and whipsawed too. It’s simply a go-to tool to help me mitigate risk. If you don’t have or know your edge, stop and rethink what you are doing and why you are doing it.

I will be keeping an eye on the euro and the dollar along with every other market player in the world. With the franc front running a very obvious move for QE by the ECB, the downtrend in the euro and the uptrend in the dollar may be entrenched for a while longer. A counter-trend catalyst could present itself at any point so keep your eyes peeled, as even shorts can be squeezed unbelievably faster than what was conventionally thought for a currency trade. There is a lot of uncertainty between the franc and the euro, which generally move quite closely with each other.

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The franc’s shift in perception back to safe-haven status while the euro is weakened by the ECB’s proposed monetary inflation has helped to muddy the waters, so to speak, in how to effectively trade them in the current environment.

On another subject, Intel (INTC) is a stock that is often commented on as being a leading indicator of the S&P 500. The same can be said for many other economically sensitive stocks such as: Caterpillar (CAT), Wal-Mart (WMT), McDonalds (MCD), FedEx (FDX), and Amazon (AMZN). I could keep going, but you get the picture. These companies are fully integrated across the entire North American landscape so that the performance of these companies can be viewed as economic indicators and thus potential leading indicators for the S&P 500.

This theory has of course been backtested and the correlations examined extensively, so I leave it up to readers to indulge their curiosities by searching the web for additional information.

Anyways, coming back to INTC; in viewing a chart of its performance and correlation to the S&P 500 over the last 20 years I did notice something curious. As 20 years is probably statistically insignificant, I wouldn’t place too much importance on what I’m about to point out but it’s still curious. Have a look.

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Using a 20-month correlation, it can be seen that a majority of the time the two are highly correlated between .80 and 1.0. However, before the start of each of the major crashes in 2000 and 2007, it can be seen that correlations between INTC and the S&P 500 took a dive towards zero and even negative correlations before recovering back up over .80. When this happened in 1999, the recovery in correlation preceded the actual correction in the larger index by about 15 months. That is only because most of the action of that period was in the NASDAQ and the recovery in correlation between INTC and the S&P 500 actually preceded the beginning of the NASDAQ’s downturn by 6 months. The NASDAQ began its implosion several months earlier than the rest of the indexes as it was the focus of the dot.com era.

For 2007’s crisis, it can be observed that the recovery in correlation back up over .80 between the two pretty much nailed the exact top in the S&P 500 to the month. And now we can see that between May and June of 2014, we saw another recovery to at least .80 in the correlation of INTC and the S&P 500 after a year-long dip. Again, I’m not implying that this is a usable signal to discern that we are near a major top in the equity markets. The last two crises had unique fundamental backgrounds and triggers, just like the next will have its own. In 2000 and 2001, we saw the bust of the tech boom exacerbated by 9/11 and the beginning of the never-ending war on terrorism. In the middle of the decade, we saw real estate financing and associated derivative leverage hasten a credit crisis that nearly took down the entire economic system. For the next one, it could very well be sovereign debt, central bank incompetence, and derivative leverage once again that initiates difficulties. I’m simply pointing out that the 20-month correlation of Intel and the S&P 500 provides an interesting signal.

Obviously, the correlation coefficient can be set to any number of months, weeks, days or minutes based on the period used for your charts. Twenty is the default parameter utilized by Stockcharts.com. Sixty is also prominently used and in the case of Intel and the S&P 500, when using 60 months, that leading pattern does not exist. So take the indicator for what it is; a simple signal of interest. Nothing more. Incidentally, if you gauge the correlation of each of the economically sensitive stocks I listed above, no early-warning signal exists between them and S&P 500. That pattern in the correlation for the potential of an early-warning of greater market direction only existed with INTC. Happy trading, speculating, investing, winning, and losing.

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