Trading a Panic

How to Trade A Panic

 Martin A. Armstrong

Note: This is reprinted from the April 1994 issue of the World Report.

Most people believe that it is impossible to forecast the wild and crazy panic moves that any market will go through at varying intervals over the years. It appears that most people think that when panic strikes, market behavior is totally random and that when markets move in a steady sideways trend that they are somehow exhibiting NORMAL behavior that complies with the standard methods of forecasting and analysis.

I have been fascinated by chaotic price swings for nearly 30 years. As a young boy, I was quite lucky in the mid-1960s fooling around in commodities—namely the precious metals. My father was a very conservative man with a background of being a Colonel who served with General Patton in North Africa and Europe, an attorney, postmaster and a judge. My Great Grandfather apparently made a lot of money in the stock market during the 1920s only to get hurt during the Depression. In 1966, my father felt that I was too much of a speculator wheeling and dealing in the commodities market. He urged me to be more prudent and invest in the stock market. I did, and bought virtually the highest print of the year in a leading mutual fund. I watched that investment plummet from $54 a share to about $7. I turned to my father and asked if this was the way conservative people made their money.

Between 1966 and 1970, I ventured into several investment arenas ranging from rare coins to real estate. Without exception, each and every investment within its own time moved from the peak of absurdity (when everyone simply had to have it) to the black depths of oblivion (where you literally could not give it away in some cases).

Fortunately, I was young enough to survive my losses and learn from the experiences. By the time 1974 came around I was well seasoned. My experiences taught me a lesson that no learned institution could ever hope to instill in a student. The diversity of investments exposed me to the common denominator that to this day few have noticed or dared to understand; no less investigate.

It does not matter what the investment instrument might be, there is NO inherent value in anything unless someone else believes it to be so. Consequently, nothing is immune to a panic and today there are many who are just beginning to learn their own personal lessons with the most touted “conservative” investment of all time—BONDS!

Markets do not panic—people do This is why there is no safe investment no matter what anyone wants to say. The rocket scientists who have devised fancy delta-neutral trading strategies were wiped-out in the recent steep declines in bonds. One fund lost more that 100% of its client—s money ($120 million) in the derivatives market last month. What the scientists failed to realize is that when frightened—people panic. When that fear strikes the heart of market makers—you end up with no liquidity.

One of the unique aspects about our models almost always leaves people quite perplexed. That aspect stems from our Reversal System and the fact that it works BEST during big panic moves when virtually all other models FAIL! There are several reasons for this strange characteristic inherent within our Reversal System, but the most important one is due to HOW the research was done from the outset.

US 30 Year Bond Nearest Futures
Month Open High Low Close
10/93.. 11820 12206 11720 11824
11/93.. 11822 11828 11409 11516
12/93.. 11510 11730 11409 11416
1/94.. 11416 11728 11311 11705
2/94.. 11704 11706 11112 11213
3/94.. 11214 11220 10520 10608
4/94.. 10618 10708 10224 10416

My experiences as a youth fascinated me with panics and big moves. I realized that no matter how good an investment appeared, there was always a risk of collapse and panic. The more everyone touted that such a panic was IMPOSSIBLE, the greater the probability that one would in fact take place.

Keeping this in mind, my research concentrated upon the big moves. I felt that there simply just had to be a point which if crossed would spark that panic selling in any market. From physics I learned that the more something moved to one extreme, the greater risk that the smallest amount of pressure would cause the greatest amount of change.

The Reversal System was born from this foundation. It emerged from the quest to find that hidden point within price movements of ANYTHING when, if crossed, would spark an avalanche of selling or buying. Every previous panic was analyzed and tested and the formulae were revised and retested again and again. The ultimate goal was to find a tool which was not subjective; one that would state its findings in black and white and work in all time series. The Panic of 1893 was the fastest drop—yet short-lived in comparison to the Panic of 1929. The model was tested and survived in every case possible, regardless of whether it was an index, stock, bond, commodity or economic statistic. It worked because the common denominator was people and people panic, not indices.

For these reasons, the Reversal System simply works BETTER during wild price swings than during quiet strolls through a sideways trading pattern. The sole purpose was to highlight the pressure points within any time series and warn of risks to either side of the market.

From this background emerges the nagging question—How to trade a Panic? To answer this let us look at the recent events in the bond market by beginning with the December 1993 issue of this report (Issue #13).

The Monthly Bearish Reversals that were published last December on page 22 were as follows: 11714, 10908, 10801, 10324, 10301, 10113, 9920, 9712, 9709, 9413, 9318, 9217 and 9215. Some very short-term traders are far too quick to dismiss the long-term numbers we provide. They think that since they can only be elected at the end of a month, they are of no consequence to them. This is a big mistake if you are truly interested in understanding how markets behave during panic moves.

Monthly Bearish Reversals
11714, 10908, 10801, 10324, 10301, 10113, 9920, 9712, 9709, 9413, 9318, 9217 9215
Weekly Bearish Reversals
11420, 11416, 11131, 11114, 11113, 11023, 10631, 10604, 10427, 10315, 10222

In Table #2 we have combined the Weekly and Monthly Bearish Reversals(MONTHLY)* in order to visually see how the underlying support in the bonds was and is laid out. The strongest support areas are identified by CLUSTERS of reversals in the same general price level. For example, strong support lies in the 103 zone, 97 zone and 92 zone. The market will eventually be attracted to each of these support zones and the Reversals between each zone will be capable of producing TEMPORARY support along the way. Therefore, a monthly closing below 10301 will lead to an INEVITABLE decline down to the 9712-9709 level and a monthly close beneath 9709 points to the test of the 9217-9215 area.

Table #2 – Reversals Map
11420 11416
11131 11114 1113
10631 10604
(10324)* 10315 10303 (10301)*
9923 (9920)*
(9712)* 9712 (9709)*
(9217)* 9217 (9215)*

()*=Motnhly and Weekly

Now let us look at how the market has responded to these Reversals thus far. The first Monthly Bearish Reversal in the list was 11714. This was elected at the close of November 1993. This was the first warning that the high might be in place at that time. As long as the September high of 12210 is not exceeded, then the model tells you that in a bearish trend you should move down to test the next Reversal beneath which in this case was 10908 on the monthly level. However, Table #2 shows several weekly numbers between the 11714 and 10908 monthly Reversals. The bonds fell to the 11409 level and the week of December 27th produced the lowest weekly closing at that time (10416) which was precisely our second Weekly Bearish Reversal! The Weekly Bullish Reversal from the January 3rd week was 11730. The bonds rallied back up into the week of January 24th reaching 11728 intraday. Notice that this rally and Bullish Reversal was very close to the first Monthly Bearish at 11714 which had been elected at the end of November. Rule #1: If a market is very bearish, it normally rallies back to retest the last elected major reversal.

The week of February 14th finally produced a weekly closing below 11416 and the following week the bonds pressed lower intraday reaching 11112. You can see in Table #2 the bonds moved from one Reversal level to the next. The next week (Feb 28th) saw the bonds rally back up to 11220 failing to exceed even the previous week—s high only to collapse again to close for the week at 11024 electing all 3 Reversals in the 111 area but holding the next one at 11023. The following week (Mar 7th) opened at 11025 and rallied only to the 11118 level, retesting the previous 3 reversal clusters and again failing to exceed the previous week—s high. The bonds then turned south dropping to 10827 to close that week at 10930. The next Reversal in Table #2 was the Monthly Bearish at 10908. This FAILED to provide precise support warning that the bonds were still in a weak position. The week of March 14th provided a reaction establishing a trading range of 11109- 10912 closing lower at 10920 still indicating weakness. This reaction failed once again to get through the overhead cluster at 11100. The following week (March 21st) opened at 10915 and the high was 10921. The bonds started to sell-off again dropping to 10718 and closing on the low! Now the bonds had penetrated and closed below the next Reversal in our Table #2—10801. We could see in our Table that there was some support in the 106 area but the major support was clearly down in the 103 zone. The next week (March 28th) saw the bonds crash dropping to 10418 and closing at 10420. This elected 3 Weekly Bearish Reversals—10631 10604 and 10427. A move into the 103 zone was now virtually guaranteed!

The precise day of the Economic-Confidence Model was April 1st. The markets were closed that day so the next trading session was April 4th. The bonds continued to fall bottoming precisely on April 4th at 10301 closing at 10308. Finally, a Reversal held precisely signaling that at least a temporary low might be at hand. This was at least a major CLUSTER of Reversals and some important support should be expected.

The first Daily Bullish Reversal from the April 4th low stood at 10706. If the 10301 low was good then the bonds MUST elect a Bullish Reversal. The bonds rallied into April 13th reaching 10606 intraday failing to get through the previously elected weekly bearish reversal at 10604 and 10631. The Daily Bearish Reversals generated from that high were 10414 and 10309. April 18th closed at 10313 electing the first Reversal. The bonds fell to a new low the following day reaching 10224. This was but 2 ticks above the Weekly Bearish Reversal at 10222. The settlement that day was back at 10401, so the 10309 Daily Bearish was not elected! Instead, the bonds launched a sharp rally reaching 10708 on April 28th. This was 2 ticks above the 10706 Daily Bullish Reversal. However, the bonds fell like a stone closing that same day at 10424.

This brings us to the present. The bonds have resistance at the Daily Bullish Reversal at 10706 and support at 10301 on a monthly closing basis and 10222 on an intraday and weekly closing basis. If the bonds penetrate the last low of 10224, then there will be little choice but decline down to the 10113 level. The 10113 level is a Monthly Bearish Reversal which is more important than a daily or weekly. Some support is likely to be found at that level. If the bonds BOUNCE precisely from that area, then you will need to know where the Daily Bullish Reversals are from that new low. If the bonds cannot close back above them, then you will look for a move back down once again. The previously elected reversal in this case will range from 10301-10324. If the bonds fail to get through this level, then look out below. Table #2 shows two Reversals at 9923 and 9920 and 3 Reversals at 9712 and 9709 combining weekly and monthly models. Both of these areas are stronger support and are capable of producing at least important temporary lows.

So the question remains—How to trade a Panic? Thus far throughout this decline you can see that the Reversal System works very well during big moves. If you arrange the Reversals from our Monthly Reports as in Table #2 and combine these with the Daily Reversals from our Daily Fax Reports, you will have the best possible MAP of exactly where support and resistance stands at ANY given time in the market.

Nevertheless, having the best MAP possible does NOT always lead to the best trading possible. First it takes GUTS, PATIENCE and UNDERSTANDING. Second it DEMANDS DISCIPLINE! If you second guess every tick in the market you are TOO CLOSE to the trading activity and you will only INCREASE your risk—NOT LOWER IT! No one can PERSONALLY call every little turn within the day. Trying wave counts, pattern recognition or cycles will NOT help by themselves. Emotions run high and losses with them! A successful trader must ELIMINATE his personal subjective decisions as much as possible. NEVER EVER allow a position to move BEYOND what you expected to be resistance or support. Fearing to get out of a position because you are wrong leads to even bigger losses. If you are losing on a position NEVER spread yourself—JUST GET OUT! All of these are KEY rules that lead to successful trading that will be better than 70%. But the number one rule is ALWAYS DEFINE WHERE YOU ARE RIGHT AND WHERE YOU WILL BE WRONG! If you cross that point at which the trade is WRONG, simply GET OUT! It is this rule that our Reversal MAP can help you the most. It will clearly define where resistance and support lie and in doing so where any trade is RIGHT or WRONG!

You MUST trade according to the MAP our Reversal System provides. You sell on each Bearish Reversal and place your stop above the opposite Reversal (Bullish). You can take your profit using MIT orders against each new Reversal you approach and reenter when penetrated. If you cannot handle the risk, reduce the amount you are trading! Panics are rare but very profitable from the short side. One simple technical rule—a good PANIC never exceeds the high of the previous trading session. If you look at when the Panic in the bonds began (week of Feb 14th), the bonds NEVER exceeded the previous week—s high until the week of April 11th. This move saw the bonds fall from 11515 to 10301 NON-STOP on a weekly basis. At the very least, the previous week—s high can be used as a stop loss during a Panic. The odds are that if the market exceeds the previous week—s high, then a temporary low is in place. It would NOT be a wise decision to go LONG on such a technical rule. It should be used ONLY as a stop loss rule!

For those who are new to our models you might be prone to think that one example does NOT make a system valid. This is a true observation. Take our last few reports and make your own tables. You will notice that gold fell to 368.00 basis spot during the week of April 18th. This was a PRECISE Weekly Bearish Reversal generated from the January 3rd high. In Crude Oil one of the Weekly Bullish Reversals generated from the December 1993 low was 1728. The precise high for the week of April 25th was 1728. The examples are endless. If you are diligent and serious about trading, then make your MAP of our Reversals and watch it closely. You will be amazed at how well it works in keeping you one step beyond the emotional chaos that normally prevails throughout the market.