The Coronavirus Impact on the Markets and Why Things aren’t Quite as You Would Expect
This week’s report will be a little bit different. I've taken an extract from a recent Master Pattern Trader session and provided it for you here.
I think you'll get a lot out of it, because it addresses the key strategies I use to consistently make money as a trader.
Let’s start by talking about outlier events, with the obvious example being the coronavirus that’s dominating the news headlines right now.
People have asked me how I trade outlier events that (apparently) drive the markets. People ask how I can predict events and profit from them. It must be really hard, right?
In my opinion, trying to predict movements is no more challenging than in the past. My philosophy is that patterns indicate what's going to happen in the future irrespective of events. And this past week has been an outstanding example of that.
Let me show you an email I sent to members on February 16 discussing USDJPY (the U.S. dollar against the Japanese yen) as USDJPY was at the 111 – 112 area.
I didn’t believe in the recent uptrend in USDJPY and thought the recent rise was nothing more than a false move. That’s because the bearish governing patterns hadn’t yet been busted.
Note that two weeks ago, there was no panic over the coronavirus. All the coronavirus hysteria started last week. I just observed USDJPY patterns and the price action and reported on what they told me, which was that I felt USDJPY would drop. I was willing to throw in the towel if USDJPY went over 113 but not until then.
In that email, I also discussed GBPAUD and GBPNZD (the British pound against the Australian dollar and New Zealand dollar) and that they remained in consolidation mode before the next major move up.
Despite a lot of volatility in those pairs, I wasn’t abandoning my bullish stance. I thought it was just a matter of time before they broke out to multi-year highs due to the strength of their bullish patterns.
I finished with XAGUSD (spot silver) where my main point was that the tepid price action of silver made my very reluctant to jump aboard the long side.
Silver was still in a long-term bear market despite all the emotional excitement over it in recent months.
That’s why I had my doubts about the staying power of XAUUSD (spot gold). I thought silver was likely to act as a drag on it despite the much stronger bullish patterns for the yellow metal.
I’m pointing this out to make the point that I don’t react to events.
I react to price patterns and price action, not events.
And please note that I wrote all the above views BEFORE the coronavirus panic set in and proved my forward-looking views to be correct.
I really want to emphasize that events tend to be catalysts for where the price action is going to go anyway. The pattens bake the future price action into the cake, so to speak.
So with all that backstory in place, let’s look at how the various instruments (USDJPY, GBPAUD/GBPNZD, XAGUSD, XAUUSD) did.
We’ll start with XAGUSD (spot silver).
When you examine any market, you must first determine its overall condition or trend. Are we seeing a bull market or a bear market? Until proven otherwise, you stay with the main trend.
Now of course, bull markets and bear markets end eventually. However, traders often call the turn prematurely. They fail to note that when markets change, there's always a pattern that proceeds that change. Plus there’s price action afterward that must support that pattern.
Otherwise that bull or bear market hasn’t actually ended. If you jump in too quickly, you’re going to be trading the wrong way against the trend.
Just seeing the pattern isn’t enough. When I used to spot a double bottom or a double top, I often thought that pattern was “enough”. That was in my younger days, though.
Over the years I’ve learned (and taught my Master Pattern Trader members) that you need confirmation after a particular bottoming/topping pattern occurs. That’s how you know it’s the real deal and be truly confident.
Here’s what I mean:
Silver hasn’t done that. It’s why I’ve been saying despite that despite silver’s apparent double bottom, I'm not convinced it really is a double bottom until silver can take out $19.65 and $21.15. I said that several emails and several weeks ago too!
I'm pretty proud of not being duped by the recent silver rally. You see, trading is a function of not only spotting the opportunities but also the pitfalls and traps the market lays for you. Silver’s rally was certainly one of the latter.
In fact, if you dig into silver’s price action, you can see key reversals where the market made new highs and then closed on the low of the week. Those are bearish signs and they capped each attempted rally.
So there’s no bull market in silver … yet. At best, silver will go sideways despite this worldwide pandemic (and associated hysteria) right now.
Now here’s the thing: I guarantee that if you were watching Bloomberg or any other business channel where they're talking about the coronavirus nonstop, there's no way you could be bearish or even neutral on silver (or gold). The “mood” should be perfect for a silver price spike based on what’s being talked about on the media.
Yet price action analysis tells a different story. That’s how you separate the noise from the reality.
This is why you should shut off the news and watch what the price action is actually telling you.
So let’s move on to spot gold (XAUUSD), specifically the recent destruction we’ve just seen in the yellow metal. I had hoped there was more upside left in gold’s tank, but I didn't want to chase it on the long side because I was afraid of a plunge. Which is exactly what happened last week.
If you’re a regular reader, you’ll know I made an enormous amount of money in gold when I went long at $1,479 and got out at $1,607. However, I haven't made a long trade in gold since. Yes, I saw the yellow metal taking off to $1,700 and I could have made money.
But if I had overstayed my welcome by three days, I would have been hit with a big loss despite all the initial gains.
What’s more, I was concerned enough with silver’s ongoing bear market to feel that it would ultimately drag gold lower too.
That’s why I sent out an email before the plunge about how we could potentially profit from it:
That call turned out to be correct. We went short gold at $1,635 and made $55 including $51 in a couple of hours. Maybe it was lucky, but I don't think so.
We simply took advantage of the most likely price direction with a low-risk entry (a sell stop) when all the momentum was in our favor.
Gold now has a very difficult hurdle to overcome, if you’re a bull. It’s more likely to go down than up and I’d be inclined to short any rallies at this time.
Again, I want to point out that these are a great example of how background noise and emotion weigh up against the reality of price action. So yes, we've had hysteria. We even had a presidential news conference about it. Yet gold could not get past its all-time highs. It stalled out.
And when something stalls out, it often goes the other way very quickly.
The same thing happened in the stock market too. Here’s the Dow Jones Industrial Average (DJIA) daily chart:
At first, the DJIA made a new move to all-time highs. But then there were multiple days where the index stalled out. There was one inside bar after another.
I’ve always said inside bars at the top of a range look very innocent, but they can be the catalyst for a huge reversal. There are in fact 5 inside bars on this daily chart. Together they represented coiling of energy that had been driving the rally to that point. But once that energy couldn’t push the market any higher, it stalled. Suddenly all the air was let out of the balloon.
It certainly didn’t hurt that all those inside bars occurred right at the apex of a double top.
Now the coronavirus is the scapegoat for this, but all it did was light the match of a tinderbox that was going to explode at some point. Obviously, we'll need some time to get perspective on this.
But it’s well known that the market can take three years to go up, but just three days to give everything back. Here’s the weekly chart for the DJIA:
You can see the index has reached the same low as January 2019. It gave back in a week what it built in 13 months.
This is what I've been fearing for quite some time. We have an incredible buildup of global debt. The global debt to GDP ratio has never been higher. Corporate debt has never been higher and then there’s consumer debt, student debt and so on. That’s why I’ve looked on in amazement as this market just kept rising.
And now we've never seen the market reverse 10% so fast in the history of the stock market.
That’s why I don't think you should fight the tape on this one. I’m inclined to stay on the sidelines and perhaps short any rallies that seem particularly vigorous.
So where have I been placing trades while avoiding the long side of the stock market?
I've been camping out with long positions in GBPNZD (and GBPAUD too) so here’s a chart of GBPNZD (the British pound against the New Zealand dollar):
You can see that GBPNZD took out the highs this past week and pulled back from there. This pair could pull back more, but I don't see any reason to abandon my long position even if drops more.
That’s because GBPNZD is hugging the upside of the neckline of the most recent double bottom.
It’s still poised to break out. And quite frankly, even if it dips back down again the momentum remains to the upside here. Both double bottoms and the rounding bottom tell me GBPNZD is going much higher. It’s just a matter of time.
Looking at these patterns is why I’m able to just keep the faith here. It’s all based on what I see.
A governing pattern is one that dictates the price going forward. And even though the original double bottom was four years ago, you can see GBPNZD has gone 4,000 pips higher since. It's not been easy with all the volatility. But this pair is still 4,000 pips higher in what’s amounted to a stealth bull market.
I’m anticipating it will turn into a runaway bull market at some point. For now I’m biding my time and trusting that these patterns are going to get me to my destination.
It's the same reason why I’m being bearish on USDJPY (the U.S. dollar against the Japanese yen). I'm pretty proud of this call because for the last two months I've been looking stupid saying this pair is going down.
As you can see, USDJPY was rallying every week. I stated wasn’t going to swing at that pitch even though I sometimes do take countertrend trades for a couple of hundred pips in profit.
But not this rally. That’s because the chart suggested all the big money was to be made on the downside.
My reasoning was that USDJPY was still making lower highs within the confines of the descending triangle. If USDJPY had truly made a bullish triple bottom (as some were suggesting), then we wouldn’t be seeing lower highs.
I’ll admit that when the price broke through the trendline of the triangle, there was a question of whether this represented a breakout or a fake-out. But last week confirmed my suspicion that the move was a fake-out. It was a bull trap where the bulls bought a false breakout and now they're sucking wind and don't know where to get out.
Just like with the DJIA, when these markets turn, they turn with a vengeance.
Remember that the governing patterns are what will guide you as to the market’s true character.
The double bottom in GBPNZD (and the head and shoulders and descending triangle in USDJPY) are proof they work.
When you see these patterns, they dictate the behavior over time. They give you a sustainable chance of extracting big profits from the market.
But you have to be patient to wait for the real opportunities. Don’t get distracted. Bide your time and wait for the opportunity. Wait for the market to come to you. If you're instead feeling like you're missing out or you're chasing emotions, you'll lose.
So you have to look at these things very objectively. That’s why I was on the sidelines during this USDJPY rally for three months while saying the pair was still short.
And remember, patterns act as catalysts for events. Of course, the coronavirus is an outlier. But all it did was capitalize on the patterns that were already being formed by the price action.
Never mind the media claiming that a particular event is why a particular market crashed (or rocketed). In just about every case I can recall, the patterns were showing that the market was ready to crash (or rocket) weeks before. It’s almost uncanny. But that’s how I’ve seen the markets work time and time again.
I hope this report has been good evidence for making my case. The markets are ahead of the news. The markets are ahead of the events. Identify the overall trend and the governing pattern and make your trades based on that.
I hope you got a ton of value out of the content of this discussion and I wish you a very healthy and prosperous trading week.
Mark "PerceptionvsReality" Shawzin