Following the dramatic turn in the markets over the last 24 hours. (Which included an over 7% decline in the Nikkei - After an 85% rally since October's low) - I am reminded of Dannis Gartman's Trading Rules - Rule Number 11 in particular rule number 11. Respect "outside reversals" after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more "weekly" and "monthly," reversals.

 For those of you not familiar with the rules. - Here they are:

Dennis Gartman’s ‘22 Rules of Trading’. (As of Sept 2010*)

*The rules are periodically updated

1. Never, under any circumstance add to a losing position.... ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!

2. Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

3. Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

4. The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is "low." Nor can we know what price is "high."

5. In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many.

6. "Markets can remain illogical longer than you or I can remain solvent," according to our good friend, Dr. A. Gary Shilling. Illogic often reigns and markets are enormously inefficient despite what the academics believe.

7. Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones.

8. Try to trade the first day of a gap, for gaps usually indicate violent new action. We have come to respect "gaps" in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important.

9. Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In "good times," even errors are profitable; in "bad times" even the most well researched trades go awry. This is the nature of trading; accept it.

10. To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technical. When we do, then, and only then, can we or should we, trade.

11. Respect "outside reversals" after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more "weekly" and "monthly," reversals.

12. Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds elegance.

13. Respect and embrace the very normal 50-62% retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen... just as we are about to give up hope that they shall not.

14. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights.

15. Establish initial positions on strength in bull markets and on weakness in bear markets. The first "addition" should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements.

16. Bear markets are more violent than are bull markets and so also are their retracements.

17. Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are "right" only 30% of the time, as long as our losses are small and our profits are large.

18. The market is the sum total of the wisdom ... and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom. If we learn nothing more than this we've learned much indeed.

19. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.

20. The hard trade is the right trade: If it is easy to sell, don't; and if it is easy to buy, don't. Do the trade that is hard to do and that which the crowd finds objectionable. Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.

21. There is never one cockroach! This is the "winning" new rule submitted by our friend, Tom Powell.

22. All rules are meant to be broken: The trick is knowing when... and how infrequently this rule may be invoked!

Is the AUDUSD in the early stages of turning UPDATE?

I posted an article in Feb questioning whether spot AUDUSD FX was in the early stages of turning lower, that article can be seen here . At the time Spot Aussie had just broken below 103.00 and was heading to the major support at 101.00, this was tested but the market held, and subsequently  rebounded to the top of the large sideways range which has been in place since the middle of last year. Last week however the market finally broke down through the 101.00 key support area. The upper 2 charts show the update of the 'Descending Triangle' type pattern which we highlighted back in Feb on the long-term charts, together with the weekly chart showing the breakdown. This would appear to be a significant move, occurring as it did on high volume (See lower chart) would appear to support the idea that this is part of a move which may have 'legs'.

Significantly there are fundamental elements which have been occurring which support the idea of a generally lower level for the AUD versus the USD. The past 2 months have seen a narrowing in the spread between Australian and US 2 year government bond yields by about 50 bps.  Last week's saw the Australian Central Bank cut rates by 25bp, and produce a report that growth is likely to disappoint going forward. - Further to this, general weakness in commodities in recent months, and the continuing story of slower growth in China, form a negative backdrop for the Aussie Dollar.

Where may all this be heading? 

The drop below 101.00 is seeing the market now flirting with the psychologically important 100.00 level. - If the market can sustain a general hold below 101.00 (I would not be surprised to see this level re-tested at some point), then I could see the market make an eventual attempt on the support area from 94.00 to 96.00. - My hunch would see even lower levels at some point, though a clear move through 94.00 would probably come after a bounce from that 94.00-96.00 support area.

‘Lies, damned lies, and statistics’: Forecasters are never wrong - Even when they are wrong.

Ok so this is not about trading or investing, but how easily could we apply the following to the many market forecasters, predictors, gurus and scribblers.

The following is taken from an article on the BBC website in relation to the appalling medium-term/long-range forecasting record of the British Meteorological Office (The Met Office). Full article can be seen here:  http://www.bbc.co.uk/news/science-environment-21967190.

To summarise; last spring the UK suffered a switch from extremely dry almost drought-like conditions to incredibly wet with heavy downpours and seriously flooding. The Met office had stopped publishing long-range weather forecasts after a series of terrible high-profile failures in recent years; however they continued to publish ‘secret’ advisories to government contingency planners. – The article relates to the prediction for spring last year, issued in March. The 3 month advisory stated:

•  "The forecast for average UK rainfall slightly favours drier than average conditions for April-May-June, and slightly favours April being the driest of the three months.”  

Fast forward over the next 3 months, and these were examples of newspaper headlines:

• ‘Wettest April in the UK for over 100 years’
•  ‘Areas of UK see three times their average rainfall in spring’
•  ‘UK environment agency: Three months April to June - More rainfall than at any time since records begun.’ (Which was in 1910).

A failing that is so completely obvious, that to even try to deny it would just be incredulous. – And yet, full marks to the Met Office’s chief scientist Prof Julia Slingo who says:

•  ‘Last year’s calculations were not actually wrong because they were probabilistic’.

Hhhhmmmmmm. Let’s just repeat the first part of that quote:  ‘Last year’s calculations were not actually wrong’. 

  – It remains me of a wonderful quote by Charles Darwin: ‘A Mathematician is, a blind man, in a dark room, looking for a black cat, which isn't there”.

It might just be more sensible for them to admit that Yogi Berra is right: 

Finally - In keeping with the theme. - Here is a fantastic video clip called 'African Rain'. Try listening to it first without watching. - Then watch it.

'Rain_Rain_Rain' image courtesy of Christian Southworth / FreeDigitalPhotos.net.

EU - Have they just scored an own goal?

This weekend's announcement by the EU, whereby they have imposed a haircut on the bank depositors of Cyprus, seems to me to be at first sight to be a massive own goal. Of course I accept I may be wrong, but having played a pretty good game in very difficult circumstances since the start of the European Sovereign Debt Crisis, it seems like they may have started something which puts everything before it at risk.

On one hand I think can understand what has happened to drive this move. - The people of the European creditor nations are 'fed-up' with the recent Status Quo: That is using the proceeds of their hard work, for which they pay their full taxes on, to bail out the profligate debtor nations, who’s workers receive generous state support for doing relatively less work, and then hardly paying any taxes. Then as if to make matters worse, they receive nothing but scorn and vitriol for bailing them out. - Political forces in the European Creditor Nations, or more to the point Germany, though influenced by other nations - in particular Finland, are re-shaping and this required a tougher response for this bail-out. - Cyprus has enabled the politicians a perfect opportunity: A small nation with little real political clout and where political strife and popular anger may not make the television 'Breaking News' bulletins as often or with such high profile as would be the case of other larger countries. - Though this could easily also be seen as a cowardly move, picking on a small nation with little political clout to appease popular opinion.  

However, in doing so the EU have possibly started something far bigger; a fire-storm, that could easily get out of control and undermine banks across the Eurozone, particularly within the debtor nations which have thus far they have been shoring up these banks. At the same time they are putting their own credibility at stake, and possibly unleashing uncontrollable political forces.
Picture the scene across any nation now that may at any time demand or require a bank bailout or a further bank bailout. What are prudent savers going to be doing? I am sure they are sensible enough not to be running to the bank to be withdrawing deposits, however who knows? Enemies of the Eurozone will be rushing to capitalise on this story, scaremongering will be ripe, it only takes a few photos or TV shots of queues building up outside banks to start a rush. - Perhaps it will not be a rush however, this does not mean it is not happening: Large depositors may be quietly moving their money from local banks to safer havens, or even solid shiny commodities that they can leave safely stored in their name somewhere. - This will not be purely a knee-jerk reaction, they will almost certainly be thinking that if this gets out of control there are 1 of 2 options open to the EU. - 1 is to re-consider this weekend’s Cyprus decision, which would seem the obvious step. However the EU’s credibility will be massively questioned, and whilst it seems easy to criticise this move as 'Stupid', the truth is this is a response to shifting political forces which played a part in shaping this, and it would be interesting to see how much room there is for a re-think.  2 - Is for it continue, if however suddenly huge cross-borders capital movements suddenly start becoming an issue, then I doubt that even the SNB could avert EURCHF diving below 1.2000 without some form of capital controls. - There are many other potential outcomes to this, but I do not want to even go there at this stage.

The initial response this morning in markets has been understandable, though perhaps not as dramatic as perhaps it could have been. - EURO lower on all crosses, but just back to last week’s levels, and off the worst levels as I write. Gold up, stocks down, bank shares somewhere around 3 – 4% lower.  At the moment, the market has purely re-marked prices, and is now in a wait and see mode……. Perhaps I am being more pessimistic than necessary, but, I am not typically a doom-monger, my cup tends to be half-full, and I certainly do not subscribe to Zero Hedge’s ‘the world is about to end’ doctrine. – But I must admit, this weekend’s events may just be the little grain of sand, which drops on to John Mauldin’s insecure mountain of sand, which triggers a much bigger collapse in the whole pile.

"Grunge Flag Of Cyprus" image courtesy of "creativedoxfoto" at FreeDigitalPhotos.net.
"Euro Sinking In Sea" image courtesy of "Stuart Miles"  at FreeDigitalPhotos.net.

USD - Good possiblity of further gains ahead.

This is very interesting – In my opinion we are seeing a good possibility of significant further gains for the USD across the board. 

Though with EURUSD at a pivotal zone, immediate direction is slightly uncertain. Holding above this level could signify a rebound, though a clear break though would be a blow and suggests to me EURUSD will head lower.  – Note: This is on weekly charts, so caution as verification may be needed, and intraday overshoots could be misleading.

See EURUSD weekly chart below.

What would be really interesting is if turns out that the move higher from the Head & Shoulder pattern of past 12 weeks have been a false/misleading breakout. – Often when that turns out to be the case, the market corrects back towards (and often hits) the head of the pattern, with a break below the right shoulder low (1.2660) usually being a key confirmation of this.

Here is an example of a similar turn of events on USD10 Year Yields in 2008-2010. (Though clearly on this example the head of the pattern was not hit, the emphasis however is on the consistency and size of the move lower).

Note: The break out of the right shoulder extreme has already occurred on the USD INDEX, though the fact that GBPUSD and USDJPY are part of these baskets would have contributed to the different dynamic there (See below)

I am not taking this as implying anything else for any other markets, currencies or indices. This is purely based on these charts. – Note however, the prior AUDUSD analysis continues to unfold……