When will the Market Chop?

Ask the right question to get the right answer.

As we end the first week of notoriously erratic month, many traders are seeking trend where none exists. This ‘July Chop’ takes many victims as many markets fail to trend. They also frequently take out shorter term levels that would ordinarily indicate sustained moves but then reverse back into consolidation. The generally non- trending nature of July is reflected by its historical average true range.

Forewarned is forearmed. However, a totally cynical (or non trending) disposition can be dangerous. Some instruments have been known to start trends in July that only really gather momentum later. The start of the EURUSD collapse in 2014 is a prime example.

But such trends more often than not have a reason and one that becomes increasingly apparent in the relatively sparser stream of news. In 2014 it was the resolution of the Greek debt crisis that unleashed a prolonged but bearish sentiment. Today’s newsletter seeks to explain how sentiment and news combines in a fairly consistent manner throughout trends and consolidation, at least well enough to help develop effective trading strategies.

We have previously highlighted how the impact of news is both complex and dynamic but still open to effective interpretation. News may often be inconclusive confusing and affect some markets more than others. The current impact of the Trade war and rotation between indices is adequate testimony. However a news release will pretty much always belongs to a continuum—that is a narrative that helps explain what is driving a market in trend or indeed stops a trend at least in the short to near term. In this instance, the series of tariff news is a narrative that has restricted a rampant inflationary growth inspired stock uptrend to a trading range for much of 2018.

The extent to which news will help or hinder a trend in the shorter term depends more on the market’s interpretation rather than the real impact of that news. Our Economic Release fractals ( a map of how instruments move before and after the release) can provide real insight into how the market typically reacts short term through the period.

This clearly depends partly on whether the number beats or misses expectations and therefore supports or negates the economic narrative. But It also often depends more on how sentiment and positions drive the market in the short term. The average of what an instrument has done previously on a particular release shows how the resulting price action can be at odds with a straightforward interpretation of the number due to this change in positions. The fact the market does not appear to learn from these frequently counter-intuitive reactions begs the definition of insanity that is wrongly attributed to Einstein.

Even if we can and do nail the market’s sometimes bizarre reaction to news, this ‘edge’ can itself be subject to a sudden death. Short term sentiment and movement does not last and will be replaced or subsumed by the next important event or news whether it belongs to the same narrative or not. In other words, these sentiment driven short term events releases form part of a series of a broader narrative. Wednesday’s FOMC minutes was quickly eclipsed by expectations of Friday’s NFP.

But both belong to the new variant of (not) inflationary (sustainably high?) growth narrative. However in the longer term, that real impact of the more dominant (fundamental) narrative will determine where the market will go. That is, this stock uptrend can only be maintained if we do or continue to get real inflationary growth. And it will reverse if and when expectations of inflationary growth disappear.

If much of the short term price action before during and after an economic release can be attributed both to how sentiment moves around the release outcome and the underlying narrative, then the same point can be made about any scheduled potential market moving event, for example a Trump or Fed event. Markets are fractal. They have a habit of moving in a similar fashion before and during such events as this reflects decisions made by traders confronted by similar risk assessments within an underlying narrative or trend. Indeed a similar point can be made about different time zones and Opens and Closes as price movement gives an indication at least of how sentiment/positions are changing. What they do after will depend where the event lies within the underlying narrative or trend.

And this is the crux. How markets react to news is an important indication where they are within a particular news cycle, narrative or trend. Adverse news and price movement that is quickly unwound is often found where the trend is not mature. That is the correlation between the price movement and narrative is strong, New highs or lows before an event are more associated with tops and bottoms where sentiment has become so extreme traders go so far as to front run the event. Periods of consolidation reflect a market indecision often between dominant news narrative, for example inflationary growth and counter-trend adverse news, eg the Greek Debt crisis 2014. These are typically resolved by one of the narratives waning.

Our delay in outlining specific trading strategies surrounding news events is because we believe some if not all of these issues can be crystallized into a series of questions about the news event, underlying trend, and price action. If that is the case, then the answers can be distilled into an algorithm and a different trading strategy for all such events.

The key to markets lies not so much in having the right answer, but asking the right question. The definition of market sanity (and not insanity) may ironically be getting the same result over and over again after asking different questions.

Here’s to making the very best.

Good Luck

Ed Matts
Matrix Trade

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