Contrarian Trading

Market action is suggesting a sell risk approach (sell US S&P 500, Aussie 200, oil, copper, AUD/USD, EUR/USD) – or is it just me?

One of the factors traders must overcome on the road to profits is personal biases. When it comes to share markets, most of the traders I know are “natural” bears. That’s not me – I’m a natural bull. However, I love an argument – a characteristic I share with a lot of traders. This translates into a natural bias to go against current market thinking – I’m a contrarian. This is why I have a big problem in trading in the near term.

At the moment I can see both technical and fundamental reasons to sell risk assets and currencies. Bullish on risk for all of Q4 2011, now that the market consensus is turning bullish, I want to sell. The question must be asked – is this fair analysis, or simply a natural bias?

Here’s a chart of the US SP 500 Index from the Tracker platform:

As illustrated, the index is approaching multiple resistance at previous highs at 1350, 1358 and 1367, and the Stochastic oscillator is in overbought territory. Looks like a sell to me.

While I remain fundamentally positive on risk over 2012, there is a real possibility that markets have run ahead of themselves. The US data clearly shows recovery. However, it was Europe that triggered a great deal of the 2011 sell off.

After Greek political leaders again deferred any announcements on debt reduction and commitment to bail-out requirements, the potential for disappointment is rising – yet the muted reaction in markets suggest there is comfort both these announcements will come. The US Federal Reserves chairman Bernanke re-iterated last night that the Fed stands ready to increase liquidity (QE3) if required – does he know something we don’t?

Anything less than comprehensive commitments could start a short term sell-off – and the track record of European politicians generally, and Greek politicians in particular, is not good. I’m going short ahead of a potential sell trigger on Euro disappointment.

About michaelmccarthycmc

Chief Market Strategist - CMC Markets and Stockbroking Regular on ABC, BBC, Bloomberg, Channel TEN, CNBC, SBS and SKY
This entry was posted in Commodity, Forex, Market, Shares, Stocks, Trading and tagged , , , , , , , , , , . Bookmark the permalink.

18 Responses to Contrarian Trading

  1. George "Kevin" Muir says:

    I totally agree, Michael. Very perceptive comments ….. as usual!

    I intend to follow your advice. Thank you.

    All the best!

    Kevin

    • michaelmccarthycmc says:

      Thanks for your comments Kevin. Should point out, I don’t give advice -just highlight what I believe to be market opportunities. Whether its a trade for you is entirely your decision. All the best in the markets

  2. DV4 says:

    I agree michael, on the S&P chart you have shown here there is a bullish gartley pattern in the middle (see the 3 wave correction), the market is hitting the first target 127% extension around 1351 which is the old highs for the last year or so… so we have a cluster of a pattern target + old highs + RSI and Stoch overbought (but not confirmed)… Re copper I agree.. there is what I believe is a weekly or monthly gartley short pattern off 394 which was a major support resistance level going back years, and the 61.8% triangle target, on the copper weekly chart if this week closes bearish, then it will be an evening star at the top of the 2stddev bollinger band that clusters with old resistance going back to 2006 – 2008…so a pullback is likely

    • michaelmccarthycmc says:

      Thanks for the comprehensive rundown DV – just like a lot of this blog’s readers, I learn a lot when experienced traders comment.

      • DV4 says:

        Just my own beliefs… time will tell…
        I always find these posts interesting, thanks for taking the time to share them!

  3. DV4 says:

    I am lightening up on my longs and only keeping those that I am comfortable giving back some (possibly significant) ground on in case QE3 kicks in… which would be great

  4. Hello Michael great comments! As a former stockbroker, and now serving as a Wisconsin State Legislator, could you give me more insight into the statement “Anything less than comprehensive commitments could start a short term sell-off – and the track record of European politicians generally, and Greek politicians in particular, is not good. I’m going short ahead of a potential sell trigger on Euro disappointment.” How will their track record effect our market?

    • michaelmccarthycmc says:

      Hi Jason – the concern is that Greek politicians will focus on their political futures rather than the economic imperatives -an election is due within 6 months, and some Greek parties are pushing for an immediate election. Announcements were due last Sunday that private investors and the Greek government had agreed the terms of a re-structure of existing debt, and that all Greek political parties agreed to implement austerity reforms – a condition of the Euro bail out of Greece.
      Greece has 14 bio Euros of debt to repay by March 20, and there are a number of financial processes that must unfold for the bail out funds to be received by that date. If I’m right in thinking that the lack of announcements so far indicates negotiations are stalling, and may fall over, this will lead to the re-emergence of talk that a Greek default is imminent, and fear of financial contagion will re-emerge. This is likely to lead to global selling of risk, including American shares.
      These debt issues hit the headlines more than two years ago – since then, there have been many statements of intent that exceeded subsequent action. This is the track record I referred to.
      Thanks for your contribution.

  5. xsor says:

    This is trap when people think that market is self-sufficient. I have short S&P 500 at 1310 and get my stop loss. Remember COM bubble? You can short, but price can double it. People learn to live with the risk, psychologically people will ignore the risk if risk is getting permanent.
    Please have stop lost in place and short index for long can be very costly.

    • michaelmccarthycmc says:

      Agreed Xsor – risk management (in particular stop loss orders) is always important, but especially so when looking for a trend change.

  6. DV4 says:

    Wow what a great discussion, I will wait for confirmation before shorting S&P, at the moment it is in a roaring uptrend and I don’t want to step in front of a freight train without more reasons backing it up

    • michaelmccarthycmc says:

      Fair call DV. My approach is dfferent – I use tight stops, to limit costs, and am prepared for multiple stop outs. The pay-off occurs when I pick a turn – the immediate pay-off can be substantial.

      • DV4 says:

        Fair enough, by more confirmation I meant either candlestick rejection pattern, divergence or a reversal pattern on lower time frames to prove it is respecting the level, and allow for a solid stop level. But you are right, at the end of the day it comes down to win% and avg. reward/ risk ratios, (basically expectancy…) and each to their own, I am back testing a reversal strategy at the moment and I understand what you are saying. it does not have to win often if it can have huge R;R ratios >3-10:1 when you win.. when you chart expectancy, you will see you can win23% of the time if your average R;R is 4:1 and still make money, drawdowns will be nasty and an ugly equity curve… but it will make money if you position size right…

      • michaelmccarthycmc says:

        Yes – the approach requires a more conservative value at risk / capital ratio

  7. xsor says:

    I think because we get high fast and people start to think that upside less likely than downside.
    what is more likely for you:
    S&P500 + 40 points
    or
    S&P500 – 40 points
    I think most people with say second one.

  8. Andy P says:

    🙂 I am a natural bear, but the S&P has behaved as it is now (uncannily so) within the last couple of years and shows the rally can run much further with little pull back. I’m not saying history will repeat itself, just the rally we’re seeing shouldn’t be considered that unusual based on previous behaviour (granted the world is different now).

    For what it’s worth, I think a sell-off / decent breather will come when there is some genuine good news in Europe or the US and there aren’t enough ‘new/late/dumb’ buyers to feed the ‘old/early/smart’ sellers (of which there will be many based on this run).

    Risk management, risk management, risk management! I keep an eye on SKEW, VIX cash vs VIX futures and any abnormal divergences between VIX/SPX as clues smart people are getting nervous / positioning for the downside.

    • michaelmccarthycmc says:

      Thanks for your comments Andy – you make several good points. We ran a study on the S&P 500’s correlation to the VIX (cash). It showed a value of -0.85. Remembering correlation values fall in a range from -1 to +1, this is a very strong inverse correlation.

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