Coincidence? I Think Not

Into The Future

One could say that a futures contract predicts the likelihood of a future event.

The price of a futures contract is created by traders who will be rewarded by
turning a profit if they are correct and will be punished with the loss of money
if they are wrong.

Therefore, we can say that the price of a contract, which represents the opinion
of the market, is more valuable than the opinion of any individual analyst or trader.

A good example of this is the Fed Funds Futures contract, which trades on the
CBOT (the Chicago Board of Trade, which merged with the Chicago Mercantile
Exchange last year).

This contract currently predicts that the U.S. Fed Funds rate, currently
standing at 2.25%, will fall to 2% after next week's FOMC
(Federal Open Market Committee) meeting.

The likelihood exists for further rate cuts beyond next week, but the contracts
seem to be saying that this cycle of rate cuts will end sooner rather than later.

Perhaps if these future traders believe that Bernanke and the Fed are nearly
finished cutting rates, the U.S. Dollar will finally find some support.

The greenback's dizzying decline has been a topic in this column since its
inception, but the damage to the U.S. currency has accelerated in recent
months.

The Euro has made an incredible run, racing from 1.45 to 1.59 vs. the U.S.
Dollar since early February, as seen here on the daily chart
(see Figure 1).


Figure 1: EUR/USD has rallied 1400 pips since early February. Source:
Saxo Bank

If you caught my appearance on the BBC last Friday, you heard my
prediction that after a period of consolidating its recent gains, the EUR/USD
currency pair will continue to rise, possibly to 1.70 by year's end.

If that sounds farfetched, consider this: while a rise to 1.70 from the
current 1.59 would require a gain of 1100 pips, or 11 cents, Euro has
already gained 1400 pips (14 cents) vs. the greenback in the past 2 ½ months,
and has climbed a whopping 2600 pips (26 cents) since August of 2007,
as seen here on the weekly chart
(see figure 2).



Figure 2: Weekly chart shows EUR/USD climbed from 1.33 in August 2007.
Source: Saxo Bank

Kudos to the BBC interviewer for remembering that on my previous visit
last fall, I predicted that EUR/USD would rise to 1.60. At the time this
sounded pretty outrageous,
since the pair was trading around 1.40 last fall, but it sure doesn't sound
far fetched now.

EUR/USD touched 1.5980 last week, a mere 20 pips from 1.60, before
pulling back slightly to its current level near 1.59.

Hunger Strike

Singapore is allowing its currency to strengthen gradually vs. the U.S.
Dollar, in a bid to stave off the inflation that is rampaging through
economies here, driving up food prices and creating a dangerous situation
for the many who live on the brink of starvation.
The greatest risk belongs to those countries who are dependent on
food imports.

Just yesterday in West Bengal, workers and students held a strike to
protest rising food prices; a similar strike occurred in India's fourth largest
city, Kolkata.

In Mexico there is a saying, "when the tortilla rises, the government
falls," and some analysts are predicting a crisis in that country.

In Thailand, nearly half of the respondents of a survey said they are
cutting back on rice, which is ironic because that country is the world's
largest producer of rice.

According to an official of the Asian Development Bank, "The era of
cheap food is over."

Who is to blame for this problem? The media seems focused on bio fuels
as a cause, because grain harvests are being diverted to gas tanks instead
of dinner plates.

But this is not the entire answer. Because some people are panicking and
hoarding food, supplies are scarcer than they should be. Speculators are
jumping on the bandwagon, driving prices higher.

High oil prices make it more expensive to harvest the crops and ship the
products, and these expenses are passed on to the consumer.

Unintended Consequences

One thing is for certain; the current low-interest rate environment is not
helping the situation.

Central banks fight inflation by raising interest rates. Meanwhile, the
Federal Reserve, the Bank of England, and other central banks have
been cutting rates and adding liquidity in a bid to prevent a recession and
the collapse of major financial institutions.

The Fed is particularly culpable, because Ben Bernanke and company
have cut rates by 300 basis points over a relatively short period of time.

This has caused tremendous inflation in the U.S., arguably much higher
than the reported inflation rate.

Now consider that many countries have tied their currency to the
greenback, meaning that they are also importing inflation along with
the U.S. This inflation is having a ripple effect throughout the world.

I would argue that over the past decade, every time the Fed either
pumps up liquidity or goes on a rate-cutting binge, they are
unintentionally creating a bubble.

Right now they are doing both. Remember Y2K? The Fed pumped the
system full of money in 1999 because they were afraid that a computer
design glitch would plunge the world into chaos when the new century
began.

So where did the money go? Much of it was funneled into the Nasdaq,
creating a spectacular tech stock bubble as the index eventually climbed
above 5000, more than twice its current value today, eight years later.

After the tech bubble crashed, the U.S. entered a recession. In order to
create growth for an economic recovery, the Fed under Alan Greenspan
cut interest rates to 1.00%.

The unintended consequence this time was the housing bubble, as real
estate prices in the U.S. and elsewhere skyrocketed to unbelievable
heights due to low mortgage costs, along with a hefty dose of
unscrupulous lending.

Now that the housing bubble has crashed, the Fed is once again
on a mission to provide money at low rates.

Simultaneously, we are seeing the creation of a third bubble, this
time in the prices of commodities like oil, gold, and most importantly
food.

Coincidence? I think not. Perhaps it is time for the Fed to realize
that we can't solve our problems by just throwing money at them.

Instead, we just end up with bigger problems. Cutting rates and
adding liquidity is fine, but doing it in drastic fashion creates
unintended consequences.

Aurthor

Edward Ponsi

The Bulls Get Spring Fever

After spending most of the winter on the defensive, the bulls have finally been able to put together a blossoming rally in the past two weeks.

Talk of "the worst being over" is pervasive on the street now, and a bit of optimism is coming back to the market.

The perception now is that the Federal Reserve, through its recent actions, has shifted their main priority to providing a backstop to the fragile financial system; hence, fighting inflation has been placed on the back burner.

Whether or not this sanguine view is warranted -or even misplaced - is tough to say. At least in the short run, the market wants to believe it.

With the uncertainty of the first quarter reporting season kicking off this week, and more bad news on the economic front (a subpar jobs number and a record low pending home sales number), conventional wisdom would dictate that the market should have reacted negatively.

The mere fact that the market has held up well, under the constant barrage of bad news, perhaps is a bullish signal.

From a technical basis, most of the major averages are up against some important resistance levels (more on this later).

In our trading discussion today, I want to touch on a common misconception among many novice traders, this is the view that in order to realize big gains, one has to assume big risks.

This may be true if the beginner is not schooled in the true ways of how the market works or is relying on extraneous information, such as advisory services or the latest indicator.

This, in my opinion, is not the way to gain a trading edge, learning to identify inflection points and trends is the most important lesson for the would-be professional.

Indeed, once the trader gains proficiency in pinpointing these levels, he or she must muster the courage to take these trades - as often times these are not what would be "feel good" entries.

I frequently hear students say, "I'm waiting for confirmation before I take the trade", and as is regularly the case, by the time they get that confirmation, they end up chasing price and skewing the risk-reward ratio.

In my view, the only verification needed to take a trade is having the conviction to know the probabilities are in your favor.

In the illustration below, I've highlighted some recent low risk entries utilizing the Keltner Bands concomitantly with support and resistance.

In past newsletters, I've commented on my use of this channel as a way of measuring extended markets, the set-up is quite simple: When the price approaches one of the bands, I look for the nearest support or resistance levels and place a limit order around that price point - along with a 10 tick protective stop.

If I'm correct, it's usually a 5R (5 to 1 reward to risk), as the market tends to snap back dramatically from such stretched levels, If I'm wrong, and yes, this does happen, I lose very little ($100 per contract in the ER2).

The reason I use this set-up, and have been for many years now, is that I've gained the confidence to know that it works a high percentage of time.

The reason why only 10% of futures traders make money consistently comes down to the fact that they will take these types of trades, on the other hand, the 90% that lose consistently will not take these low risk trades because of FEAR or because they lack the knowledge of what support and resistance truly means.

In our usual fashion, let's review the technical picture of the E-mini Russell ER2, additionally, going forward, I'm going to start looking at the S&P, as I've been getting more inquiries about this popular index.

The hourly chart of the ER2 below indicates we're still trending higher off the March lows, the important support level in the near-term is 705 with resistance at 721. The ER2 along with the S&P are in extreme overbought territory, and as previously mentioned, are touching major resistance areas.

In the daily chart of the S&P e-mini (ES) below this resistance level is evident. This area looms large, if the bulls are to continue their charge.

To recapitulate: In my last newsletter, I made the case for a rally lasting several weeks. Since then, (although it hasn't felt like it) the Russell and S&P have rallied 60 and 70 points respectively.

So, where are we headed from here? We are in a tougher situation now, the recent move has put the market in an overbought condition and this has to be worked off.

Moreover, earnings season tends to add further uncertainty, which makes things a bit dicier, I sense we're setting the stage for a battleground (range-bound market) that will probably not be resolved until the reporting season winds down. In the meantime, find low-risk, high-reward trades and get on the side of the 10%.

Until next time, I hope everyone has a profitable week.

To recapitulate: In my last newsletter dated March 19 , I made the case for a rally lasting several weeks. Since then, (although it hasn't felt like it) the Russell and S&P have rallied 60 and 70 points respectively. So, where are we headed from here? We are in a tougher situation now. The recent move has put the market in an overbought condition and this has to be worked off. Moreover, earnings season tends to add further uncertainty, which makes things a bit dicier. I sense we're setting the stage for a battleground (range-bound market) that will probably not be resolved until the reporting season winds down. In the meantime, find low-risk, high-reward trades and get on the side of the 10%.

Until next time, I hope everyone has a profitable week.

Gabe Velazquez

www.educational-dvd.com



DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.
Reprints allowed for private reading only, for all else, please obtain permission.

The Qualifier - Support (demand) and Resistance (supply)

Last week, we looked at indicators and oscillators and wrapped some very logical rules around them.

We did this because if you take every buy and sell signal an indicator produces, your trading career is guaranteed to be short lived.

It is not that the indicator is not working properly, they always work exactly as they are programmed to work.

The issue is that most traders don't use indicators properly. Today, we will apply some more simple yet important logic to conventional chart patterns.


There are many chart patterns such as Triangles, Flags, Pennants, The Cup and Handle, The Head and Shoulders, and many more.

While I chose to stick to pure demand (support) and supply (resistance) in my trading, many new traders like these conventional chart patterns.

One thing all these patterns have in common is that the entries are all "breakouts". No matter how much you like these patterns however, whether each trade taken ends up in a gain or a loss depends 100% on the supply and demand equation at the price levels to which price is breaking out into.

In other words, before pushing the buy or sell button to enter the breakout, you must assess the "profit margin" to make sure there is room for price to run, after you enter. Let's look at some examples.

Here we have an intra-day chart of RIMM. Notice the Descending Triangle. While it looks to be a picture perfect pattern, whether we take it or not depends on the profit margin.

In other words, where is the first support (demand) level below our short entry point, which is a break of the bottom of the triangle?

We can see here that there is plenty of room to the first target and a little more room to the second target. In this case, shorting that breakdown from the triangle is fine. Had support below the triangle been too close, this trade likely would not have worked out.


Let's now look at a daily chart of DRYS. Here again, we have a picture perfect Descending Triangle.

The difference in this case is that the support level below the triangle is somewhat close meaning our profit margin is not ideal.

In the RIMM example, our reward to risk was about 5:1. In the case of DRYS, our risk reward is much less because support is much closer to our entry point.

This profit margin may still be fine for some traders but the point is, you must know what that profit margin is.

To quantify your profit margin, you must be able to quantify demand (support) and resistance (supply) based on objective information.

Keep in mind that the task of quantifying supply and demand is beyond the scope of this article, however, we do cover it extensively in class.

Here we have the popular "Bear Pennant". This one seems to be a class favorite and that's great, as long as you know where your objective targets are.

In the case of EBAY, we can see that the support level gives us a decent profit margin as it is well below our entry point.

This pattern, just like the descending triangles is a continuation pattern. Notice in this example, price spends very little time in the pattern.

This is typically a very good sign. With all these patterns, the less time price spends in the pattern, typically the better the outcome.

Why write about conventional chart patterns you might wonder? Along with my trading, I teach the Stock, Futures, Options, and Forex classes for Online Trading Academy and in all of these classes, I always find some people looking for the conventional chart patterns.

The two issues that they fail to consider are the difference between profits and losses and they are as follows:

Almost all the entries for conventional chart patterns are "breakout" entries. This means you are going to have a hard time getting a good fill on your entry order so be careful not to chase price too much.

If you miss the low risk entry, let it go. There is always another trade.
People need to realize that you can have a picture perfect chart pattern and it can still fail miserably.

When this happens, it is because the breakout entry was right into a support or resistance level.
There are many ways to trade and keep your trading low risk and high reward. You can use chart patterns, indicators, Moon and Star patterns, and much, much more.

The one governing dynamic that will determine the outcome of all these types of trading, however, is how well you can quantify supply (resistance) and demand (support).


Sam Seiden,
www.educational-dvd.com

DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.
Reprints allowed for private reading only, for all else, please obtain permission.

The Battleground Is Set

Since the recent market lows set on January 22 and the subsequent rally, stocks have essentially been range-bound. The tug of war between the bears, that feel we're only in the early innings of a protracted recession, and the bulls, which are beginning to see the light at the end of the tunnel in regards to the current financial crisis is in full swing. Who will take the spoils in this battle is anyone's guess. What's more certain though is that the elevated volatility the markets have been experiencing lately is not going away any time soon.

If we examine both points of view, each has its merits. The recent data clearly indicates a slowing economy: Unemployment claims have risen to multi-year highs, home foreclosures are skyrocketing, and the bond insurers are on the verge of bankruptcy. On the other hand, the Federal Reserve's humongous rate cuts will gradually work through the system providing the much-needed stimulus to enable a speedy recovery. In addition, the view that the market has largely discounted the worst-case scenarios in a lot of the financials, retailers and other economically sensitive stocks, is also a plausible argument.

Until this is all sorted out, large intraday swings will be the norm. In this type of trading environment, both longs and shorts have to be nimble to capture profits, as trends seem to reverse on a dime. This market setting is not one to reward the stubborn or greedy. To this end, I advise newbie traders that they have to "manage their expectations".

In my experience, I find traders – much to their detriment - are too slow to react to continually changing markets. Managing expectations helps in the adapting to these changes. Specifically, a day trader must identify early in the session, what type of trading day is unfolding. He/she should ask these questions. Is the market trending? Is it a choppy day? Alternatively, are we in a reversal day (one direction in the morning and a counter move in the afternoon)? Once this has been ascertained, the decision making process is made a bit easier. Why, might you ask is it easier? Well, at this point you can elect to trade or stay away. This decision will be predicated on how your particular methodology performs in current conditions. If the method has performed well in the past, then of course you should trade. However, if the present market is not your bailiwick, then you probably shouldn't trade. Regrettably, newer traders haven't gained the necessary experience to trade in different market conditions, or try to implement methodologies designed for specific markets i.e. trend following, breakout etc., in all environments. As a result, what usually happens is that after a string of losing trades, a perfectly good system is often discarded prematurely; when in fact, the real issue is in the person implementing it. The takeaway here is to learn which market works best for you; once you've figured it out, trading will become more fun and more importantly, profitable!

Let's shift gears now and look at the charts. Below is an example of just how many swing moves are occurring in a single day of trading. On Tuesday, there were seven mini-trends (indicated with red and green arrows). As I mentioned earlier if you didn't take some kind of profits during the day, you were left with nothing.

In the daily chart of the E-mini Russell, what's noteworthy is the triangle that seems to be forming. This is indicative of the battleground between the buyers and sellers. Similar to a coiled spring, the impending move should be violent. The direction is not certain but it's beginning to look like an upside move is more probable.

Finally, the hourly chart of the ER2 distinctly illustrates the 20-point range that this market has been largely confined to for the last two weeks. Again, this bears out the notion of uncertainty among market participants. Although, I do expect this will resolve itself fairly soon.

In summary: Today's market has become hypersensitive to just about any piece of news about the economy, subprime, and most recently, the bond insurers. I'm getting the sense that the market has largely discounted most of the bad news. Also, supporting this idea is the fact that the public has become extremely pessimistic. All the recession talk being bandied about has soured consumer confidence. All the while, major corporations and their execs are buying back shares at a very healthy clip. I see this as a good omen for the market in the intermediate-term. In my opinion, this all adds up to more upside for the market in coming days. Regardless of what the market does, make sure that your expectations are realistic and positive.

So until next time, I hope everyone has a profitable week.

Author
Gabe Velazquez

www.educational-dvd.com

DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.
Reprints allowed for private reading only, for all else, please obtain permission.