*Looking at a support/resistance trade and discussing current equity markets*
Welcome back to the blog! Happy Friday and I hope you are all ready for the weekend, make sure you take time away from the markets and give your brain a rest. The markets will always be there when you return. In this blog post I am going to talk you through the pre-trade analysis of a FTSE100 short trade I have been holding for a while. I will also show you my current positions on the Dow Jones index and a US Dollar FX trade.
This is a good trade breakdown to show you this week because I have been talking a lot recently about markets becoming more and more sideways with intraday volatility increasing. I have also recently talked about trading using simple technical analysis techniques like price support and resistance zones and that is exactly how this FTSE short trade was entered.
If you haven’t read my recent blog post on support and resistance zones then please click on the link below. You will see I mentioned the FTSE100 stock market index as a potential example.
Let’s start by looking at the larger picture of the FTSE100 index and identify the key price movements over the past few months.
The chart above shows just over 2 years of price action for the FTSE100 index. the year of 2019 saw a fairly consistent bullish trend that took us to all time highs for the index before the coronavirus pandemic hit and the large sell off occurred. From there we saw the Q2 recovery caused by the government and Bank of England stimulus and then the inevitable market chop and sideways price action which is where we are at now.
I shorted the FTSE100 index at the 6300 price level which was where I identified a clear price resistance zone that was stopping price from going higher. This is very basic analysis but it coincided with my fundamental analysis of the stock index and sometimes simple is just best.
This 4hr price chart shows the price resistance zone more clearly. As you can see, I shorted at the 6300 resistance zone that had previously held strong multiple times and was the top of the price channel that has seen the FTSE100 bounce sideways for many weeks now.
Price is now breaking through the lower 6000 support zone and I believe over the next few weeks it can continue to fall. Unless there is some miraculous vaccine breakthrough and the economy suddenly finds thousands of jobs for the unemployed and businesses re-open, there is no fundamental reason why the FTSE100 index will start to consistently trade higher.
Now, let me propose a philosophy to you.
Do not fixate on the direction of price but instead focus on the true value. Look to go and buy one dollar for 50 cents because you know it’s worth is double. Don’t pay two dollars for a single dollar because you think it is going to be worth four dollars. This is the key to long term investing.
Now don’t get me wrong, I am an active speculative trader of the financial markets and do not follow this theory in everything I do. If you have purchased my Mastering The Markets – Retail Trading Course you will know that I use price action direction and momentum to enter trades that are often very successful. However, when trading stock market indices at the moment I think it is very important to use the philosophy stated above.
Intraday volatility is high, stock markets are acting erratically and individual stocks are even worse. Therefore it is imperative to look at the bigger picture and look at the true value of the underlying assets you are trading to make sure you are positioning yourself in the right direction.
A very relevant and great example of how not following this philosophy when buying a stock will lead you in to trouble is the Eastman Kodak Company (KODK). They have been in the news this week and have seen trading volume of their shares increase by more than 20x overnight. The current stock price chart is below.
There are two type of investors or traders that are buying and selling Kodak shares this week.
The first are those buying according to the philosophy I said earlier, they are buying because they have seen Kodak received a huge government loan to put them into a new industry that is currently booming. They bought in at $8 per share and $20 per share the following day and sold at $30 or $40 dollars per share. Therefore, at that point in time, the current value of Kodak shares were undervalued and one dollar was trading at 50 cents. These people also managed to get very very lucky and the “one dollar” shares they bought for 50 cents were soon trading at “5 dollars” and they sold their shares because the successful investing philosophy was no longer true for that asset.
The second group of Kodak buyers are those who are not following the investing philosophy I mentioned earlier. These people were buying Kodak shares at $40 or even $50 per share because they had seen that price had gained 300% over the previous 2 days and they wanted to get involved on the next 300% movement. At that point on time, these people were buying one dollar for the price of two dollars in the hope of it being worth four dollars.
There funny thing is that at the point the first group of investors sold and then the share price continued to climb from $40 to $60 per share, many of the second group of buyers would have been laughing at them and mocking them for missing out on another 100% of returns. But look what happened through the very next trading day and decided for yourself who is the smart one.
Dow Jones – Short trade
My Dow Jones short trade started life as a lower timeframe momentum trade but I got rather lucky and managed to pick the very near highs of the stock market price recovery. I took a large portion of profits from my original trade because it was high risk and held the balance of short positions through the market chop and sideways price action that followed.
Much like the FTSE, the Dow Jones stock index then formed resistance at around the 26,800/27,000 price level and i could see that it was likely that if this zone held strong then price would start to fall once again. This is because the fundamentals just don’t align with price and sooner or later they will converge. I will talk about this more later in this blog post.
USDCAD – Long trade
I have got a small intraday long position on the USDCAD FX currency pair right now. It uses the basic principles of support and resistance and buying low/selling high. There was clear price support at 1.33500 this week with price failing to close properly below that level. I entered a long position on the close of multiple 1hr bullish wick rejection candles with a stop loss order placed below the previous candles.
I am looking to trade this pair up to 1.35 where there is a previous support zone which will now likely act as resistance for price to not go higher. I have made this trade risk free by removing exposure with my stop loss order now at my trade entry price. I will monitor this trade on the 1hr timeframe chart and if strong selling momentum comes back in to the market then I will close.
Stock market prices are supposed to be fully efficient and incorporate all data in to pricing but from experience we know this isn’t always the case. It is also a fact that the current market price of a stock is based off its future earnings (it’s future value). We know this is the case because Tesla is the perfect example of how a current stock can trade at huge multipliers of it’s current revenue thanks to investors beliefs in its future potential.
However, this is a very rare scenario and in 9 times out of 10, stock prices will tend to revert back to their value instead of their fair value catching up with their stock price. This is why I am shorting both the FTSE100 and Dow Jones stock market indices because they are quite clearly overvalued. In my opinion, investors and traders that are still buying stock indices at these price levels are using models that calculate future value that include the current levels of central bank stimulus that is propping up markets right now. This is fundamentally floored because there is no way this can continue and future value from actual business revenue and profits do not justify current stock market prices.
I will leave you with one more chart to show you an asset that probably is trading at a fair value and gives a much clearer view on the overall risk sentiment and global macro views of investors.
The chart above shows the last 13 years of price for Spot Gold and a gold mining company. As you can see, Gold is now trading at prices nearly 300% higher than the lowest prices seen in 2008. This is a clear sign that the overall opinion of investors and traders is that the global economy is on it’s way to quite a “rough patch”. It can also be used to show that inflation is on the horizon and the value of the U.S. Dollar is looking rather weak right now thanks to the continued fiscal and monetary stimulus.
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