The moves in the market, now, reflect an interesting market dynamics. The Euro-zone continues under performing and the US economy is sputtering to life. The hype surrounding economic recovery is based on a market perception that has been fed with European and Japanese financial stimulus and US Quantitative Easing. As the US starts to taper the Euro-zone picks up the baton and runs the printing presses at maximum speed. Things are not right economically , but we follow the traders not the economists. Economists and politicians love a nice bull run. Traders don't care as long as something, somewhere is moving.
Markets are about perception, much of it is not real or connected to reality. The futures market is exactly that, a perception of the future. There are many perceptions of the future. Which is why people bet against each-other. You cannot compete with someone else’s perception of the future, you have to create your own. Furthermore, even though individually people tend to be rational we have seen, in history, as a group they become completely whimsical. The psychological make-up of the market is more akin to a panicky impulsive 4-year-old then a grown up.
If you follow the US market all you have to do is look at the S & P or Dow. The Dow regularly falls over 100 points and regains it based on the flimsiest pieces of news and conjecture. In the modern era where 60 % of trades tend to be through computers and neural networks trading has become much easier. People may pretend that these algorithms are super complex but the reality is that most of them just look at the prices of a few different instruments and some key Twitter accounts. They look at correlations between certain markets and also filter out key keywords from news sources and then place trades automatically.
They react. They are not really neural and clearly cannot predict much. In fact their power of prediction is far worse then human traders. However, they trade better because all the emotions associated with human traders have been taken out of the equation.
It is true, there are the High Frequency Traders and some people who are privy to inside information, but that is nothing new. If anything, inside information is pretty useless as one cannot predict how the market will react to it. Good news can be bad market and so forth. So how does one trade against these mechanical monsters ?
It is pretty clear if you are a regular market follower. The old adage about trends being your friend is great if you are trading on the daily, weekly and monthly charts. A yearly chart of the US/Yen looks very tradeable but on the smaller time frames this is madness.
High Frequency algorithms, neural networks are inherently linked to the human psyche but magnify our emotional problems. They panic buy and panic sell based on a few keywords. They muddle up correlations between currencies because the people who design them hide behind formulas and equations not the truth about markets. It is for this reason that, after the sub prime crisis, the human traders in hedge funds have a habit of turning them off and trading manually when things heat up.
Do your research, and use your system but when the market goes crazy don’t blame it on the computers, dust off one of your nice contrarian strategies and make money. There are many effective strategies based on divergence. Once you start using them you will see divergence everywhere.
Trading divergence is the modern betting against the panic. It is a tough call and not for the faint hearted but as Hyman Roth said in the Godfather II when his associate Moe Greene got a bullet in the eyeball: And I said to myself, this is the business we've chosen.
