resilient as they should be in the circumstances. And conversely, when prices rise on bad or indifferent news, traders say the market is acting well. If we are facing the wrong way, it should be second nature to all of us to cut back when the market is reacting the wrong way to the news or to the circumstances –and to be reassured when the market is acting right.
In certain cases, market action* is about all we have to go on – not just in alerting us to major speculative peaks and troughs (see below). Sometimes
price action conflicts with our script for weeks on end, perhaps mandating that we stay out of the market. This gauge isworth looking further into.
There is another description of the consensus-that’s-not-confirmed-by-price. It consists of two images that have become part of the ancient lore of Wall Street, the Wall of Worry and the River of Hope. II A bull market”, we recall, “climbs a wall of worry”; and “a bear market flows down a river of hope” .In point of fact, the description normally only applies to the early and middle stages in bull and bear markets. So we can be very comfortable when we diagnose a wall or a river –assuming we’re climbing and flowing respectively.
In the later stages of the trend, things change. The worriers capitulate to the up-trend; and the hopers throw in the towel and give up the fight against the bear. At thisstage, in a bull market, we find die-hard bears saying that, well, we are heading for a collapse, but prices are going to go up further before they head down. And in a bear rnarketl die-hard bulls assert that prices are far too low –but they can go lower still. The lconversion* processl is nearing its end. Now we have to get a little wary, for obviously we are in the region of consensus. And this is a very dangerous regional because no body on earth can tell how far things can go. Currencies, stocks, commodities – it makes no difference. In this respect they’re all the same.
It is said of Joseph Kennedy, father of President John Kennedy, that when he was having his shoes shined one day in autumn 1929, he was astonished to hear the shoe shine boy tip him a hot stock that was sure to go from 160 to 2000 or whatever. That was all Joe K needed. If shoe shine boys (or elevator attendants, or hairdressers, the cover of Newsweek or whatever) were tipping stocks, it was time to get out. So Joe K started selling short and thus laid the foundation of the family fortune –so the story goes. But if it’s true that Joe K went short at that moment then he was lucky. The sucker buys at the top of the market; geniuses and liars sell at the top of the market; but the super-sucker sells short at what he thinks is the top of the market.
In 1979, the then financial editor of Britain’ s Daily Mail newspaper, Patrick Sargent (later to be a founder of Euromoney), called the top of the gold market at around $450. It was a perfectly sound call, in the light of the speculative heat in gold at the time especially from one who had been bullish of gold for a good time. Yet gold was to climb a further $400 by early 1980, when speculation turned from red-hot to white-hot. Imagine being short at $450! As I say, no-one on earth knows where a speculative
trend will end – except with hindsight.
Over time these four sentiment gauges* have proved invaluable in pinpointing the region of the price extreme in the currency markets; and they passed the test more than adequately in the case of the most extended speculative extreme that has been seen in the currencies since they floated free in 1973, namely the peak of the dollar in February 1985.1qey allowed the ultimate peak to be categorically identified, in retrospect, in September 1985 when the D-Mark stood at 2.90 and the Yen at 230. (Some observers were smarter than this: they identified the ultimate peak within days of the top. But most of them had also identified the ultimate peak on numerous occasions in 1984,1983,1982 and even 1981!). This brings us to the question how you can distinguish a minor multi-week extreme from a major multi-month or multi-year extreme. The late stages in that great dollar bull market of 1980-85 provide a clue: you watch the way the conversion process trickles down through the different categories of currency observers. In mid-1984, the world was still full of die-hard dollar bears who had considered the currency overvalued ever since 1981. Who were they? It wasn’t the dealers, who are not and do not need to be overly concerned with underlying value; nor was it the trend-followers. It was the value-oriented analysts –researchers and economists by profession – with a long-term orientation. What happened was that some time during the autumn of 1984, the bearish consensus among this category turned round; and it happened relatively suddenly. You will see it quite clearly if you go back over the research material turned out by major banks at the time. “The dollar is grossly overvalued at DM 3.00, but we think it will head further up before it collapses”, that kind of thing.
In other words, it’s just as you would expect. When the long-termers who were formerly sceptical at last capitulate to the trend, then you have a total consensus and the end is nigh for the major multi-month/multi-year move. Nigh, but not necessarily over. At this point one of our sentiment gauges comes into its own. We have to watch market action:: the way the market acts in relation to the background and to news events.
Listen to what the market is saying about others, not what others are saying about the market.
With apologies to RICHARD D. WYCKOFF
At times chartists are the predominant influence on currencies. It’s unrealistic not to recognise this. At times, charts can help all of us trade: they tell us what the patient’s temperature is, even if they don’t give a prognosis. And on occasions they may give that too.
Traders in all markets are divided into those who know what they are doing and those who do not. That doesn’t mean that those who know what they are doing are right: they just know what they are doing. The rest operate by chance; and, it must be said, the rest are in the great majority . Those who have a system to which they adhere consistently know what they’re doing. Of this small knowing minority, a largish proportion are chartists*, or at least rely more or less on price history. And this generalisation seems to apply as much to the currencies as to other markets, or maybe more so.
Moreover on the evidence, price-oriented traders have tended to be rather more successful performers than the more numerous ‘fundamentalists’. The so-called commodity fund industry –the futures funds –is dominated by price-based, trend-following systems. Contrary to widespread opinion, the industry chalked up significant gains over the 1980s –net of substantial dealing costs.
The commodity markets are broadly a zero-sum game*, like currencies. They get little help from a secular rise in prices, as the equity business did over the 1980s (and in certain earlier decades). For a whole industry to make significant profits in a zero-sum game, after hefty dealing costs, that is strong prima facie evidence of expertise: and the whole futures industry beat the market. By contrast the equity management industry has over many years, and certainly over the 1980s, trailed behind the broad stock indices as is known to one and all. In a zero-sum game, that would be the equivalent of making losses year after year. So on the face of it, the trend-following futures funds have been doing something right.
On closer examination, what we find is that a few fund managers have been successful in compounding profits over many years, while most have shown an erratic performance. The successful ones have, naturally, attracted new funds and grown geometrically until they have come to dominate the industry. In other words, the
