Market Relationships and Their Roles in Trading Transaction - Essay Example

I. Executive Summary One of the important lessons learned in the 1980 market collapse and economic backlash is that the markets all over the world are inter-related, including its financial, non-financial, domestic and international sectors. To clearly cite this example, the U.S stock market is largely influenced by bonds, bonds in turn is dependent on the direction of the commodity market and commodity is highly dependent on the trends of the stocks market – understanding these market linkages is the key fully maximizing the market. Knowing that the market does not move in seclusion provoked inter-market technical analysis, and is the central theme of this paper. When we say that markets are not isolated, this is tantamount in saying that studying the economy of one country alone, say the United States being the most powerful country in the world, is enough to predict the international economic and financial gush. Stock traders have to be keen over the fluctuations in the bond market and bond traders in return must also pay attention to the oscillations of the commodity markets. However, in trading stocks and bonds as well as with the Foreign Exchange market (FOREX) it is not compulsory to thoroughly understand the various relationship that exists, all that is required that knowledge on specific trends, flows and oscillations are demonstrated and their cunning applications to trade decisions. Figure 1 shows the relationship between the four markets sectors, the currency (i.e. USD), the commodity market, the bonds, and stocks. As observed in the figure below, USD had a bearish influence on commodity market, the weak commodity market suggest a raise in the bond market and this raise in bonds in turn influences stocks trend. Figure 1. The Inter-market Relationships of Currency (US dollars), Stocks, Commodity Market (CRB Index) and Stocks. There are several key market relations: 1. Action within commodity groups, such as the relationship of gold to platinum or crude to heating oil. 2. Action between related commodity groups, such as that between the precious metals and energy markets. 3. The relationship between the CRB Index and the various commodity groups and markets. 4. The inverse relationship between commodities and bonds. 5. The positive relationship between bonds and the stock market. 6. The inverse relationship between the U.S. dollar and the various commodity markets, in particular the gold market. 7. The relationship between various futures markets and related stock market groups, for example, gold versus gold mining shares. 8. U.S. bonds and stocks versus overseas bond and stock markets. This paper will demonstrate these relationships and their roles in every trading transaction made. II. Why companies use stocks? Why investors invest on stocks? III. Why companies use bonds? Why investors invest on bonds? Business Cycles In order to realize the economic premise the ties commodities, currencies, bonds and stocks, it is necessary to underpin knowledge of the international business cycles and what happens to an economy during expansions and recessions. In most countries particularly in the United States of America, the bond is dubbed as an excellent indicator of the economy. A rising bond trend is an indicator that the economy is gaining momentum and strength; while a weaker bond market means that there is a possibility for economic backlash. During this period, the stock market in turn profits from the fluctuations of the bond market, hence traders bonds along with the stock market and vice versa. Bonds and stocks are common indicators of the health of the economy, for they turn down prior to a recession and bottom out if otherwise. Nevertheless, turns in the bond market usually occur first, every major downturn in the stock market has either come after or at the same time as a major downturn in the bond market. Throughout the last six recessions bonds have bottomed out an average of almost four months prior to bottoms in the stock market (cite). IV. Why companies use commodities? And why investors invest on commodities? In interpreting market trends, emphasis will be on the commodity prices hence they are important aspects of inter-market analysis. Commodity market is used to illustrate how the relationship of one sector, say bonds, can be used as vital trading information and these information as well are important for commodity markets traders in the first place. Another reason why there is a stress on the commodity market and why companies use them as well as investors invest in them is the belief that they represent a least understood part of market linkage mechanics. Many traders have emphasized that thorough understanding of the market scenario needs the recognition of the roles of the commodity market. However, working with the commodity market also encompasses monitoring specific sectors like the metals, energy and the grain market. This important connection alone makes the commodity market indispensable for many investors. Many investors and companies look into the commodity market because of the striking similarities between commodity market and the interest rates movements. In a particular time of economic development, there is an increase in the demand for raw materials as well as demand for more sources of capital/money to sustain the economic expansion. And because of this, the prices of the commodities rise in parallel with the price of money and its interest rates. With the rise of commodity prices, there is also a fear for inflation which makes monetary authorities (such as banks) to raise the interest rates to possibly neutralize the results of inflation. The increase in interest rates blocks further economic expansion which could lead to drastic economic slowdown and ultimately to recession. Economic deceleration and recession makes both the prices of the commodity market and the interest rates smaller. The patter and series of possible scenario cited here makes the commodity market an important indicator of where the economy is heading and most especially proper manipulation of the commodity market along with the interest rates prevents recession and promises large gains with the right trades. The tops associated with the bond markets give advance warnings for the coming of a possible recession, and in turn is reflective of the rising commodity market; and in opposition the falling commodity market is simultaneous with a bottom in the bond market. This relationship demonstrates the role of the commodity market in the analysis of bonds and stocks making investors and companies able to control economic flows and trends, manipulating oscillations in the commodity market. Trade No. 1 NSTC | SELL | 4,000 | Order Price: STOP at $6.20 The goal for this trade is to first impose a strict money scheme that will limit any losses by striking a stop-loss after a trade is being initiated – in this case at $6.20. The strategy here is to go for stocks that are near support levels and short stocks at resistance levels. First is to look for stocks that how positive divergence in specific momentum indicators and in the same manner will show signs of accumulation and distribution. Based on the above mentioned details, the NSTC was chosen based on its stochastic oscillator data above, and candlestick pattern was used with SELL at 4,000 price. Trade No. 2 ZION | BuyToCover | 3,500 | Order Price: MARKET The transaction for ZION uses the GAP trading strategy. Gap trading is an easy method primarily used for buying and shorting stocks. A gap in trade is the change in the price levels between the close and the open of two consecutive days – in this case, a full gap up occurred with ZION wherein the opening price is greater that yesterday’s highest. Using short example, a BuyToCover was set at 3,500 so a possibility of trend reversal (based on the stochastic map) going down to 3,000 is an indicator to exit the position and a recalculation has to be made thereafter. Trade No. 3 CEO | SELL | 400 | Order Price: MARKET Using the candlestick method in stocks exchange, the bearish harami that was formed at the middle of November is an indication that the market had made a long advance over the last four months. The plan here would be to sell short a position and have an initial stop as a market order. No stop as used for the out signal would only be favorable this time when there is a market acceptance of a new high price. Trade No. 4 GNW | BuyToCover | 6,000 | Order Price: MARKET Trade No. 5 JAVA | BuyToCover | 7,000 | Order Price: MARKET Trade No. 6 BAC | BuyToCover | 1,595 | Order Price: MARKET Trade No. 7 RYL | BuyToCover | 3,000 | Order Price: MARKET Trades 4 to 7 were all made in the same day (November 19, 2009) with minutes as interval before the transaction was made, this is a significant gap and divergence of stocks momentum are present (refer to figures above). A BuyToCover strategy was made in favor of the possibility of price reversal as well as higher gains in selling price. In the same manner, The MACD (moving average convergence divergence) indicated a BUY signal - where the faster line crosses above the slower line and both these lines are below zero. Another factor considered in the above trades, was that an UPTREND was expected to happen. If there is an expected UPTREND, it is advisable to buy stocks for if the opposite occurs (the currency will drop) you can simply buy back the stocks to close the position. Conversely, if the stocks price rises, then you can sell it with higher gains. Also, the swing size of the stocks was also considered (Figure) where a small gap and uptrend combined is a strong signal to BUY. Trade No. 8 CTSH | Sell | 1,500 | Order Price: MARKET Trade No. 9 SFSF | Sell | 2,100 | Order Price: MARKET The premise behind the above trends are simple, the stochastic indicator showed that the stocks market price is above zero - an indication to sell. In the same manner, the bearish and the bullish signals using the daily MACD or the 9-day EMA is another factor considered. If you intend to buy stocks (bearish), then look for bearish signals by utilizing candlestick methods which are also indicators that a current BULLISH trend is reversing. Using the daily trends and MACD of CTSH and SFSF, three signals were followed that indicated a bearish signal namely: the negative divergence (MACD declines over a 9-day period or from Nov 10 to 19, 2009), the bearish is moving over a crossover and there is a significant bearish centerline crossover. Considering the potential rise in trade, it is a market strategy to BUY those showing strength and sell those showing weakness, but in this case, considering the bearish and the MACD divergence (as well as the fact that they are above zero), the potentialities of bigger gains are at hand. In a study published in “The Encyclopedia of Technical Market Indicators”, they cited that some very good signals when to buy and sell stocks are given by an unsmoothed 39 period stochastic oscillator (K = 39). A BUY signal is at hand when the K is above 50% and closing price is above the closing price of the previous week. On the contrary, SELL is indicated when K is below 50% and at the same time, the closing price is below the previous week’s lowest close. A closer look at the figures for trades 8 and 9 would reveal that during the 10-day period (Nov. 10-19), the stock prices are playing below 50% suggesting a SELL without market limit as imposed by the bullish possibility. Trade No. 10 EWJ | BuyToCover | 6,000 | Order Price: MARKET When you want to enter a trade, a buy stocks to open a position, then look for bullish patterns in trade; you can also follow specific bearish bottom reversal indicators (signs that the current bearish trend is reversing) causing price to increase when you decide to sell you r stocks. Trade No. 11 SLV | Buy | 5,560 | Order Price: MARKET November 10, 2009 using the candlestick method, a bearish pattern was observed prompting for BUY strategy, where a long black body was followed by several small bodies and ending the day with another black body. Trade No. 12 GLD | Buy | 895 | Order Price: MARKET Candlestick analysis showed that a large white body us being flowed by a small black body contained within the same previous bar – this is an indication of a bearish pattern when there is an uptrend in the stochastic graph above (see figure above). The price order is limited due to the impeding possibility of higher trends as well as a drastic fall resulting to lesser gain in the selling price. Trade No. 13 UDN | Buy | 1,765 | Order Price: MARKET Trade No. 14 USO | Buy | 2,560 | Order Price: MARKET There presence of the long black body with a wider range (Nov 20, 2009 for both UDN and USO) is an indication that the prices open near the HIGH and close near the LOW suggestive of a bearish pattern. A bearish pattern would then require to BUY at a higher quantity (1,765 and 2,560 respectively). Trade No. 15 PZI | Buy | 5,480 | Order Price: MARKET Trade No. 16 UHS | Buy | 340 | Order Price: MARKET A long white body is followed by a black body, where the black candlestick opens higher that the white candlestick’s HIGH and closes at an approximate of at least 50% into the white candlestick’s body – this is a BEARISH reversal and an indication as well of an uptrend. Keep in mind, that an UPTREND shows stocks strength and based from the stochastic graph above, an opportunity to buy higher for PZI (5,480) is likely compared to a smaller quantity fop UHS at 340. Trade No. 17 OPNT | Buy | 1,900 | Order Price: MARKET Trade No. 18 CMN | Buy | 1,110 | Order Price: MARKET Trade No. 20 EGO | Buy | 1,900 | Order Price: MARKET Trade No. 21 JNK | Buy | 1,310 | Order Price: MARKET The premise for Trades 17 and 18 is based on the following figure: The daily movements on November 20, 2009 for both OPNT and CMN show positive divergence. A positive divergence happens when MACD begins to go forward and while the security is still in a downtrend position thus making a lower reaction low. MACD can either form as a series of higher lows or a second low that is higher than the previous low. Positive divergences are possibly the least familiar of the three signals used in MACD, but are frequently the most dependable and lead to the biggest moves – hence higher quantity are being made with 1,900 for OPNT and 1,110 for CMN. Trade No. 19 GG | Buy | 580 | Order Price: MARKET Trade No. 22 BSV | Buy | 625 | Order Price: MARKET Trades number 19 and 22 follow the same strategy, hence they were identified together in this paper, refer to the figure below. The pattern showcased above along with the candlestick showed a positive trend but limited to lower orders. Based on the candlestick method, a small body was observed near he high together with a long lower wick (or no wick for BSV) – suggesting a bearish patter during an uptrend. CONCLUSION What I learned and should be done: I noticed a lot of mistakes ion my trades and others, I must say were made carelessly without analyzing materials (charts) on the daily basis and most importantly by not integrating any corrections at all. I learned that staying with simple rules, old rules perhaps will make me win the game – rules such as the M and the W formations along with Fibonacci correction principles. The double top and the double bottom are two of the most widespread reversal pattern in trading as well as in FOREX. If the double top occurs following an uptrend then it is called M formation, and if it is after a downtrend, then they are dubbed as W formations. A lot of traders are well-versed with these two formations, and knowing the basics of these patterns will aid us in making good trades during tough time; also they work best with Fibonacci price corrections that I applied as a trading strategy. These double tops and double bottoms can occur in any price swings whether they are daily, weekly or intraday; and many traders find these doubles perfect for trading if in smaller swing sizes. One disadvantage of trading with smaller swings is that little profit remains in long-lasting patters after deducting commissions. Conversely, bigger swing sizes may be more expedient to trade with but only fewer trades can be made. In M formations, there are peaks at same levels and for the valleys in W formations. Keep in mind that having the same level at both M and W formations is not necessarily a guarantee for success – although a SELL indicator is at hand once the second high is slightly higher than the first high in M formations and can be largely profitable once your expected swing size is achieved. Also, pay attention to the formations developed for a double top pattern is only completed of the valley found in between two peaks is broken by a daily close; therefore the daily close of each company is closely monitored daily before making my trades. Another thing I keep in mind next time while making the trades, are the “bull traps”. These traps are likely because the highs in double tops maybe hard to identify leading us to question whether a higher price is expected or if it is a bull trap. In order to prevent this from happening, the following precautions were applied as I read daily charts: • When working work with daily data, the daily close has to be higher than the first peak. • The market price must go 3 percent higher than the first peak. • Two daily highs have to be higher than the first peak. However, the above-mentioned precautionary measures are not optimal, since the more you wait then the chance of missing profit opportunity increases; still any false breakouts may be more costly as. Any closing price that is lower that the first peak in a double top formation then a false breakout means a price change! Importance of the Swing Size The most vital determiner for a sure hit using the double top and double bottom formation lies in the size (width) of the swing; hence it is a requirement that the trader must be able to read and analyze them clearly. They must keep in mind that if the swing size is too small then there is a possibility that too much slippage might occur as well as excessive commission. In the same manner, escalating the size of the swing will conversely mean that the number of trades will decrease as well. This may not be attractive and fruitful for many traders, particularly when they have this idea that the more trades they make, then the more chances of gaining from the trades especially when attractive stocks rise are seen. However, restricting the number of trades means that there is an increase in the number of profitable trades at limited slippage and commission. In the trades I should have applied Fibonacci price corrections ultimately to get higher gains for my stock’s selling price. The premise for this application is simple; all that has to be done is to follow the Fibonacci summation and the Fibonacci ratio. This technique is simpler once a general chart pattern for corrections has already been identified. One problem seen in the trades that I made and the application of the Fibonacci price corrections is that products have more corrections that the number of its impulse waves – suggesting that products move more in sideway patterns. As a genera observed pattern the market tend to move in a sideway pattern at 70% and on impulse waves at 30%, therefore it is difficult to know when a breakout is about to happened. Based from this principle, I should have made it a point to observe the sideways patterns in order to get the most profitable trades. In working with my necessary corrections using the Fibonacci principle, I should have integrated stop-loss rule, profit target rule and the entry rules previously discussed. The trades are made where highly based on these rules as well, and as mentioned, they go hand in hand with the basic candlestick trading techniques. These strategies that I should have used will only make profit once the stop-loss is smaller than the profit target and there should be more profitable transactions than the number of losing trades – hence more attention is given at these two factors. Glossary Table 1. Transaction History Read More