Regular readers know that I make a special focus on forecasting major trend changes in my swing trading approach. Not only does that give me the opportunity to take maximum profits from the old trend, but also gives me the ability to jump on the new trend at a very early stage. For most traders, this is the ideal position to be in. To achieve this, I use my Tramline methods (for details, see my book Tramline Trading)
Of course, there are many hazards in this approach! And that is why there are very few analysts who attempt it. The conventional attitude is that ‘you can’t time the markets’. You read this in the MSM all the time. This is shorthand for ‘I can’t time the markets, so you can’t either’.
Those who can do it are true contrarians because in every case, markets top out when sentiment is very bullish and news is good – sometimes great. There are very few real contrarians who have flourished over one business cycle! Most do not have the scientific tools to pinpoint precise trade entries, nor have the stop loss methodology to prevent wipe-out.
Early in my career I set out to debunk this lazy thinking. and last week, I was presented with a textbook setup for such a major trend change in GBP/USD.
I had been tracking the rally off the Brexit low and this was my Elliott wave setup on the large scale weekly chart
This rally was a large fourth wave and I reckoned that when it finally topped out, we would see a large fifth wave down to take it below the 1.20 low. That was my roadmap – and promised major profits if correct. So the question was how high would the rally carry and where should I enter short trades?
Early this month, I noted it had carried towards the Fibonacci 50% retrace, which is a typical point for a major turn and I was on high alert for signs of that turn. If I could catch that, I should be looking for a multi-month short trade of some magnitude – and the sooner I can get on board, the bigger the profits.
One other point I should stress is this: by jumping on a new trend early, the risk of loss is lower than it would be after the trend has been in place for some time. These contrarian trades are actually safer than joining the trend along it.
am sure you have experienced the frustration of spotting a solid trend and deciding to jump on board only to get in right before a pull-back. You are then taken out at your stop for a loss only to see the market resume its original trend without you!
Psychologically, most of us are too afraid to get back in (we don’t want to feel foolish if it does the same thing again!) – and miss a major profit opportunity. Having a successful career in trading really is a question of mastering your emotions. We all have knee-jerk emotional reactions that work against success. That’s why there are very few long-term winners in this game. To win, you must find a way to over-ride your basic impulses. That is why I have developed my very simple Money Management system consisting of two easy-to-apply rules.
Trading the public financial markets is not at all like running a business or even being a consumer. When the price of bread doubles, overall consumption falls. But when a stock doubles in price, everyone wants it! That’s when the principle of herding arises – and we can use this phenomenon to our advantage. This is a great example.
So, the market was in the zone where I expected the turn – and last Tuesday, I had confirmation from an unlikely source – the BBC! It is highly unusual for the very mainstream BBC radio news bulletins to feature anything in the financial arena and on that day, it broadcast that sterling was surging to its highest level in almost two years. This is what I posted in Tuesday’s Trade Alert I send to VIP Traders Club members;
“The pound has been surging and today, it has featured prominently on the BBC news this morning. That is a signal it may well top out very soon, if not today?”
And right on cue, the market made its high and proceeded to decline.
This was the chart I posed on Tuesday and shows the lovely wedge/ending diagonal pattern. This is a classic reversal pattern because it features the required five waves – and the crucial “overshoot” on the final fifth wave.
An “overshoot” is in reality a buying climax and signals a very sharp reversal provided the market falls back inside the wedge, which it did. And that was my signal to pull the trigger to short the market using a very close stop. The other clue was the momentum divergence at the w5 high.
And I had little doubt the market would then descend very rapidly towards the lower wedge line in the 1.4050 area as indicated by my red line. And this is how that little forecast is panning out to yesterday’s close
In fact, the strength of the fall even exceeded my bearish outlook as it broke below the lower wedge line to the 1.40 level.
I must confess, I really like the BBC signal as it is yet another textbook example of how the MSM always jumps on a trend just as it is ending. In this case, the timing was perfection and aligned perfectly with the message from my reading of the charts.
For traders who shorted near the top, their protective stops were never in any danger and using the Break Even Rule, only the worst case scenario of a move back up to their entry would see their trade a wash. They are running a can’t lose trade. How many traders can say that?
Also, the latest COT data shows hedge funds still very long (‘smart money’ commercials very short) – and the potential for massive long liquidation is high.
Now the market has declined sharply, some traders will be turning more bearish and some will be taking short trades. But will they be walking into a sudden upward reversal? The odds are pretty good and so just as some are convinced they got it wrong by their bullish bias, they run the great risk of being stopped out on their new shorts trades.
You see what I mean when I say that the earlier trades are lower risk that later ones?
And the euro wasn’t left out of the strong dollar surge last week.
It has been a trendless affair since the top was put in in February. But the market has traced out a series of 1-2s with both second waves in the normal A-B-C pattern. Also, I have a lovely pink tramline pair with the lower line being tested yesterday. I believe we are set up for a very substantial decline after this line has been broken given that hedge funds remain about 3:1 long.