Talking Points:
- Liquidity is fading as holiday conditions approach, and trading should adapt to suit these circumstances
- Remarkable trends from US equities and the Dollar can extend gains, but momentum is unlikely to make for rewarding trend trades
- Limitations in market depth can leverage volatility and charge counter-trend delevering, putting runs like SPX's and EURUSD's at risk
See how retail traders are positioning in the majors using the DailyFX SSI readings on the sentiment page.
The markets have not eased off on the remarkable trends that pushed the likes of the S&P 500 to records, EUR/USD to 14-year lows or USD/JPY on its strongest three-month surge in 21 years. That raises the risk profile of the market's prevailing exposure, but it does not ensure an impending reversal. The skew between probability and potential should be monitored closely by traders, however, as convenience and complacency can come at a high cost. While an extension of existing trends is a more likely scenario, the progress that such a stretched exposure is likely to make when the markets are thinned by holiday trade would likely be meager. In contrast, the risk of a counter-trend move may be less probable; but its impact would likely be more extraordinary. That scenario is only heightened by liquidity conditions which would amplify rather than curb a panic deleveraging.
To adapt to such market conditions, traders should consider their risk tolerance, existing exposure and trading time frame. Long-held risk appetite-oriented trades may not be in jeopardy at appealing dollar-cost-averaging, but expectations for further returns during this lull should be held in check. Those trying to jump on the band wagon now though are throwing caution to the wind. In these conditions, it is better to either stick with long-held profitable investments or transition to short-term trading. I prefer turning down the charts to four hour candles with greater emphasis on technicals and looking to event risk as a short-lived volatility charge. That would mean avoiding jumping on to mature trends like the S&P 500 bull trend and even the renewed EUR/USD drop below 1.05 to instead watch for swings from USD/JPY and GBP/USD.
Through the end of this week, the fundamental threats are diminished significantly. The Bank of Japan's rate decision has marked the last major central bank rate decision for the year and the last high profile event for the week. Themes such as global speculative complacency, Brexit speculation and the US-Chinese relationship are now sleeping giants. There are a few scheduled pieces of event risk to keep tabs on - New Zealand 3Q GDP and the Fed's favored inflation indicator (PCE deflator) are notable figures - but the need for 'surprise' and the staying power present a high boundary. We discuss trading through heading into the holiday weekend in today's Trading Video.
To receive John’s analysis directly via email, please SIGN UP HERE
