Without a doubt the secret to forecasting and trading markets is knowing who not to listen to. And more often the voice that puts us off track the most is our own. For example, I would have never considered that a market with no yield or dividend could be an alpha market, yet USDJPY is now an alpha market. I know this not because anyone told me, but because the model or trading methodology I use pointed it out.
If there is one thing that you need above all else in trading, or in any endeavor, it is the knowledge and confidence that your efforts and goals are supported by a higher power. In my case, that higher power is Chaos Theory. Chaos Theory or fractal geometry studies how dynamic systems, such as galaxies, or an ant colony, or a pit full of traders, organize themselves. It is imperative that we understand that both animate and inanimate systems have always, and will always organize themselves. In other words, the solar system does not need astronomers to continue to evolve.
In our market studies, we always allow the market itself to organize the data we use to analyze and then trade from. We identify a market's individual patterns on the different time frames - for example, the 60-minute micro pattern, or the day to day pattern - and we determine if that individual pattern is bullish or bearish based on its geometric measurement. Once we have determined the bullish or bearish designation of all the patterns within a market, we highlight markets that have the majority of patterns aligned, and look for trade signals in-line with that collective pattern. In trader parlance, we are looking to buy dips in up-trends, and sell rallies in down-trends. And most importantly, we are not determining which market to trade and which direction to trade it from; we are allowing the market to make those determinations for us. In trading parlance, we are using market generated data to make all our analytic and trading decisions.
Back to the Yen pairs, AUDJPY gave an excellent example of this type of behavior this week. Despite a 3-day sell-off at the end of October, the intraday patterns held bullish, setting up a powerful rally heading into November. Below is our Pattern Ratio, which has not changed in a week. The patterns are the same as when it was e-mailed out to our students/clients on October 26th.
S- Secondary Up
Day to Day Up
60 Micro Up
15 Micro Up
Given that the majority of patterns we're aligned bullish before the start of the week displayed in the chart in Figure 1, we can see how effective using only market generated data was in keeping us on the right side of the market.
What is most helpful about this market study / method is how we use all the patterns in an individual market - the very things which confuse so many other traders - and use it to arrive at a single pattern designation, either bullish or bearish. Likewise, it is very simple to determine which markets are leaders or alphas, and which are laggards. It is also far easier to look at a black and white pattern ratio list, such as the one for AUDJPY above, than try to make the same determination by studying a group of market charts. We can also take related market groups and determine where to focus our trading efforts based on leading groups and lagging groups. There is certainly nothing new about this - buying strength and selling weakness has been around a long time. Another edge this lends us is that seeing the strength and weakness of the related market groups gives us insight into whether existing trends will continue or not. In fact some market sectors, such as blue-chips, or precious metals, actually have a leading indicator quality to them. For example, if gold is going up and stocks and USDJPY are going down, such as happened in August of 2011, then uncertainty is increasing in the markets. Likewise if gold is going down, while stocks are stable and USDJPY is strong, such as this week, then fear is coming out of the market, i.e., markets are normalizing based on historic standards.
Currently, based on the Pattern Ratios of the different market groups, we can see that the Yen pairs, and USDJPY specifically is showing consistent strength, which gives us insight into the actions of the powerful Japanese investment class. See Figure 2. If USDJPY is rising, it is telling us that Japanese investors are once again starting to invest funds overseas, which is telling us they have a growing confidence in the global economy / business cycle. If gold is falling, it is telling us that fear is coming out of the markets which reinforces the strong USDJPY thesis. And a stable U.S. stock market also supports the new born alpha status of USDJPY and the other Yen pairs. Most importantly, we are drawing these conclusions from market generated data only, and we have the confidence that Chaos Theory lends us. We know we cannot predict what will a happen tomorrow; but by watching the markets organize themselves and noting the patterns, we are confident that we can go along with where the market wants to take us.
We need to be mindful that any correction lower in the Yen pairs could just as likely prove to be as good of a buying opportunity as they were this past week.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.