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Market Sentiment: How can be measured?

A lot of traders are using indexes or at least the major one to see if the market is going up or down or does not move in either way as sideways movement. This a very helpful technique that used by traders and investors to see if the market is willing to pay some profit in either way by going long or short, or if the market is not moving at all which can be better to stay out of it.

Many traders and investors alike using S&P 500 as a gauge for market sentiment to see if the market is about to have a new breakout move or continue its original one before they trade or invest in any stocks. This approach is more helpful for traders and investors because it will prevent them to invest or trade in phases where market is not going any way, or even worst when it move or start move in downtrend.

But the question to ask here, is measuring market sentiments by using S&P 500 is a good approach or there is another index that is better in measuring the market sentiment rather than S&P 500.

Before answering the above question let us understand what is S&P 500 and how can be calculated?

S&P 500 is simply an weighted average for 500 companies. These companies are the most largest companies in U.S economy. Some of those companies have higher weight than others based in their size and how big financially are such as Apple, Microsoft. As the name imply there are 500 companies in this average. Some of these companies are consider leaders of U.S Stock market, such as Apple, Microsoft, Google, Amazon, while there are so many companies that included in this index are considered a lager companies.

From statistic point of view, when the sample number is increased the average for that sample is almost coming to normal and anomaly will be disregard. To make this simple, when there is a bad companies in that average are mixed with good companies, the value of those bad companies will be disregard since their value will not affect the average specially if those companies are smaller in weight than those good one. That was the reason that S&P 500 index broke the top that made in Feb 2020 in beginning of this year, even if there were so many companies are reporting bad earning report.

S&P 500 Break Resistance

But what if the sample size is been minimized to 200 or 100 or 50 or may be 30 such as Dow 30 index. What will happen in this case?. The answer is obvious, the average will be more sensitive. That means when there is an anomaly appear, the average will effect immediately either if that anomaly was good or bad. And here comes the important to take Dow 30 index which is known as Dow jones industrial average as measurement of market sentiment.

Dow 30 consist of the biggest companies of all sectors of the stock market. It vary from technology companies to petroleum companies as well as banks and pharmaceutical companies. The variation of these biggest companies and the limitation of this average to consider only 30 biggest companies in U.S economy which make this average a unique market sentiment specially when investors or traders want to know if it is a bull or bear market.

For example, in 2020 where coronavirus pandemic started the market wiped all its profit since 2016 in just five weeks. All other indexes such as S&P 500, NASDAQ and other European indices have been recovered from that drop except the Dow 30 which still failed to reached the top that made in Feb 2020 as shown in the pictures below:

S&P 500 break the top reached in Feb 2020
NASDAQ 100 Break the top made in Feb 2020
Dow 30 failed to break the top made in Feb 2020

As we can see from the above charts there was an anomaly. These indices should be aligned with each other and broke the top made in Feb 2020 in order to prove the sell off that started in Feb 2020 has been recovered, but since Dow 30 still did not break that resistance made in Feb 2020, it will be hard to tell if the market has been recovered from coronavirus effect or not.

Alignment for all indices is important in order for traders and investors to tell if they are in bull/bear market, and Dow 30 index shows through years if the market is in uptrend, downtrend or sideways. That does not neglect the importance of S&P 500, or NASDAQ composite, they are both good tools to measure the market sentiment, but when it come to overall result, I believe Dow 30 has the final word to decide if the market is about to move either way.

Support and Resistance as well as trendline: How to draw them

A lot of traders trying to build their strategy based on indicators such as moving average, MACD, RSI or mix of all of them. They forgot that when they are trading they are betting on the price which is the only right indicator. They are not betting on moving average being crossed or not, or if the MACD crossed the signal line or even if the RSI cross the 50 level or not. All these indicators are fine if they are used probably and as a confirmation for your trading the price action, but if they are becoming the main indicators they will end trade up with massive loss.

The only thing that can e consider as main tools that can be used in trading is the support and resistance and the trendline. The reason is not because these tools are help you to indicate the price movement, but because these tools are very good help for trades to tell her that in these are of trend lines and support and resistance the price always work in different way as expected like if it was going up then it might move to sideway or go down immediately, or if it goes down then it might shift its direction to move to the other way sharply.

These tools (trendline, support and resistance) should be drawn carefully on the chart. For the armature trades these will be just consider a punch of lines which will be placed on the chart whenever a level of retracement happen. But that is not the case. They are like a history for the previous price action against these levels and how it acts according to these level. So these level should be placed carefully and with concertation. Here is so tips that will help to how draw ( Support and resistance, as well as Trendlines).

  1. You should consider bigger time frame when you draw these lines. Not below Monthly timeframe even if you are trading in hourly based. Because Major support and resistance or trend line of monthly time frame will never be broken because trader juts think that she bought an engulf bullish candle above strong support in ( 1 hour, 4 hour or even daily time-frame). Below is an example of good entering in EURUSD in 4h time frame.
As you can see that was a good entry for swing trading

The above chart shows how the support created first with large engulf bullish candle and how the price traveled higher and then return to the same level and it also when it reached to that level another engulf bullish candle has been created which increase the odd successful swing trade to 1.1990 level. But the truth was not like that and here what happen

Price traveled for a while and then hit Monthly Down trend

As you can see in the above chart the trade that its idea created based on 4h timeframe, could not break the monthly down trend which is more stronger, and the price not reached to its previous support and resume its strength , instead of that it broke it and went low than that which resume the main down trend for the EURUSD. Check this article that I wrote about how to spot markets next move.

2. Traders should always consider volume when they draw supports and resistances specially for those who trade stocks. Because when price hit support or resistance with high volume that does not mean that the price will move to opposite direction immediately. It means that there is more liquidity at that level and there is high probability price will return back to that level and break it. It depends on the second hit for that level and the volume assigned with the price to decide if it was strong support that will make price go in opposite direction or if this level will be broke.

Price break a resistance with high volume

See in the above chart how does price make a resistance in Apple stock at 81.89 level when it hit it for the first time. Then price went down and then come back to the same level and almost hit it many times but with low volume. Once the price break it with high volume than previous days, it was valid breakout that lead the price to go up from this level which was 81.89 until it reached 140 or near to it.

3. Third approach that can be used in drawing support and resistance is when price moves in sideways. These sideways are consider the most liquidity place where volume is either accumulated or distributed and the next move will be decided inside these places. You only need to draw a rectangle surrounding these side ways and wait for price to break this rectangle and pullback to it and once its resume moving in the same direction with break out then engage.

See how sideways work as support and resistance

Mastering Support and resistance as well as trendline is not an easy job. Traders need to do it and practice it all the time in order to develop their price action based edge that will help them understand the market as well as making money out of it.

Impulse Vs. Correction wave: How to spot Market’s Next Move

Stocks market default move as all know is going up unless there is a correction move where prices will go sideways because people collect their profits or down when there is a problem in the company. But that is not the case in Forex Market where the move can be either up when the main currency is stronger than the secondary one or down when the opposite is true. In this type of market, traders who bet in the price action and its movement will find it hard to spot which move is the correct wave and which is the correction wave. It will be hard to know which one the actual direction of the price and which one is the correction of the actual move. The following is some tips that can be helpful for traders to spot which move of price is the impulse and which is the correction. Once these two movement have been identified trading will become more easier, because traders can stick to the original direction of price whenever an opportunity has been rises.

The first approach to identify the impulse and the correction is to use long time-frame such as weekly or monthly, and try to identify if the price in these time frame has multi[pl tested trend line. Once this trend line has been identified then the impulse will be always with the direction of that trend line, and the correction will be always in the opposite diction of that trend line. Like the figure below:

Multi tested down-trend line

Another approach to identify the impulse wave and/or the correction wave is using MACD. MACD has two lines, one of which is called the MACD line and the other is Signal line. When MACD line is above the Signal line and all above zero its an uptrend, and when MACD line is below the signal line and all below zero this is a downtrend. But what if the MACD is above the signal line but both below zero line, or MACD is below the signal line and all above zero line. In these two cases the market is in correction phase and once you identify the original trend you can wait until the correction phase end and the price start move with the impulse direction again . Here where you can use the MACD to see if the price impulsing or correcting:

 Above Zero lineMACD above Signal lineUptrend, impulse
Above Zero lineMACD below Signal line Correction in uptrend
Below Zero lineMACD above Signal line Correction in downtrend
Below Zero lineMACD below Signal line Downtrend, impulse
MACD and impulse and correction waves

As you can see in the below chart:

Note: MACD should be used as secondary confirming tool not as major tool. Never use it by its own, the only major tool that you can rely on is the price action and its movement.

Sometimes the correction wave has an impulse and strong wave where the impulse will be in the opposite direction of the general market, and the correction wave for this impulse is in the direction of market. Here where many traders loss their money in market specially in Forex where there is lack of volume. The only way that will help traders to avoid this types or trades is to make sure that they get in trade with the direction of general market impulse wave after the momentum of the correction wave is faded and that happened when the MACD line is crossing signal line or retrace back from it and all lines are either below zero( for Sell) or above zeros (for buy) which means that the market will resume in the main direction like the figure below.

One of the great tool that can be used to tell if the trend line (either was up or down) about to be broken and the correction wave which suppose to hit the trend-line and resume with movement of main trend line direction is about to become an impulse, is using a momentum tools such as (RSI). Once the price reached a down-trend such as the one in the figure below with high RSI that either at 70 or above , then there is a high probability that the price will valid break the trend line and move up in new up-trend and new impulse wave.

Price Hit Down Trend with RSI hit 70 or above

Those are some tips that might help traders in how to indicated which move is the correct one (impulse) and which one is the correction move. Trader need to stick to the original move and avoid trading in correction move especially if she is not experts. Because as I said before all money that traders make in the original move can be wiped of and more once the price get in a correction wave.

Trading probabilities: Clear approach to Trade Forex

Forex’s Traders always heard that trading probabilities is one of the most effective strategy that will guarantee sustainable profits and the best way to minimize lost. But many of them don’t know how to do so. This article will explain trading probabilities from engineering background in order to sustain profit and minimize lost, and most of all to make traders accept any lost and never get greedy when won because it will make trader realize that FOREX market are just a simple random movement that no one can guarantee where is the market is heading.

First of all let us prove that the market is a random movement of price where traders try to predicate its next move in systematic way but 90% failed. Many traders use indicators such as moving average, MACD, RSI and stochastic in order to decided either to buy or sell. And many traders who buy or sell based in those indicators lost there trades. why is that?

The answer is very simple and straight forward, because the market is not moving in systematic way. Because if it was, then when you buy based in these indicators you should win as well as when you sell, but since the market is moving in random way you keep losing even when you used these indicators which suppose to help you to win not losing.

Since market moving randomly, the only way to understand it is by applying possibilities or outcomes for its next move and assigned probabilities for those outcomes and see which possibility is more likely to happen next.

When traders treat market as random experiment they will understand it clearly. Any random experiment has an outcome and each outcome has probability of occurrence. If you deal with Forex market as random experiment the outcomes lie in three possibility (up, down, or sideways). Each one of theses outcomes will be assigned probability as following:

Market’s next Moveprobabilities
Up33.3%
Down33.3%
Sideways33.3%
Error0.01%
Total100%
Market outcomes and probabilities

Once siting the outcomes and their probability, traders have to build a hypothesis for each outcome and either accept or reject that hypothesis ( hypothesis mean that assuming the market will move up and then test that assumption with evidence and see if this assumption is still valid or not).

The first hypothesis is market will go up. To test this hypothesis in order to accept or reject it you can ask the following question :

  1. Is the market making higher high and higher lows, if yes that mean the market is in uptrend, and this hypothesis is still accepted.
  2. Does the market pullback to a support and retrace to its original direction which is up with strong candlestick reversal pattern, if the answer is yes then this hypothesis is still valid.
  3. Keep going in asking questions to end up with either accepting this hypothesis or reject it.
  4. Then you divided the probability for this hypothesis which is (33.3%) by the number of the questions to get probability for each question.
  5. In the above example we had two questions and the probability for each question will be (33.3/2) = 16.65%.
  6. Then let us assume that the answer for question one is (yes) it is an uptrend, and the answer for question two is (no) the retrace was not strong.
  7. That means we had (+16.65%) and (-16.65%) because the second question’s answer was no.
  8. That mean the remaining probability for this hypothesis which is uptrend is (33.3%-16.65%)= 16.65%.
  9. Now we have a probability for our first hypothesis which is one of the outcome that market is heading up equal to = 16.65%. Sometimes when all answers are not satisfied that mean we reject this hypothesis and the probability for this outcome equal =0.
  10. Now we can be certain with a probability of 16.65% that market is moving up. But the remaining percent which was substructure earlier can be added to either the down move hypothesis or sideways in order to end up with higher outcome from three which are (up,down or sideways) and see which one has the higher probability and trade it.
  11. Now you can repeat the process form (1 to 10) to end up with the probabilities for down movement and sideways.
  12. Once you preform these processes and come up with all the probability for all three outcomes then you can trade in direction of the outcome that has higher probability using price actions or any other secondary indicators such as (Moving average,MACD,RSI).

Randoms experiment can be varied from tossing a coin to see the outcome if it was head or tail, to more sophisticated experiment such as predicting the Market movement. In my opinion Forex market is a random experiment where a lot of factors contribute to its movement that hidden from the ordinary trader. For traders to understand this market I urge her to go back and study the random experiment in details to come up with a strategy – or update the above explained one – that help her beat the market by making profit consistently and accept lost. I know that will never be hard for Forex traders because they were able to make profit with this giant market but were not able to keep it because they never think about the market as it is moving randomly.

Stock Market Overview: Isaac newton’s Madness

Look at market in these days to have a general overview about what meant when Isaac Newton said that ” I could calculate the motions of the heavenly bodies, but not the madness of the people”. The S&P 500 which is considered the average of the stock market made new lower low that breaks all other previous lows and was able to retrace back to the top. It wiped all profit that made since the start of the bull move in November 7, 2016, and return back to 2967, which considered the last support before started move to what considers last bull impulse wave before the sharp dropped started in March 18, 2020 ,due to COVID-19 pandemic.

There are many contradictions between experts about the market. Some of which are considering this is a correction phase, while others consider it new bear market, and the media which is no expert in this filed consider this drop just as pump in the road.

There are several factors need to be outlined before decide where is the market going. Some of these factors are based in technical analysis while the other based in fundamental analysis. From technical analysis point of view:

  • The market makes new low and sharp drop in March 18, 2020 until it reached the bottom to 2195 points, which was below SM(200) and broke the last bottom which was in December 24, 2018 which was 2342 points.
  • This bottom was created in just 5 weeks of strong sell-off in the market.
  • After 13 weeks from that bottom, the market failed to reached to the point where all sell-off started, which means that there is high momentum in the down-side, rather than up-side.
  • The market made an Isolated Island which considered a reversal pattern below the last top which created in Feb 19, 2020 which was 3380 points. This isolated Island followed by two strong bearish candle one of which is an engulf with highest volume ever since the start of sell- off, which is a strong indication that the market will resume its down move as shown below:

From fundamental analysis point of view there are also many factors that suggested that the market is either going in sideways or down-trend but never in up-trend, and they are as follow:

  • The leading companies in the S&P 500 index which made the market moved up after its sell-off that started at March 18, 2020 which are ( Microsoft, Apple, Amazon, Facebook, Google, and Johnson & Johnson, UnitedHealth Group Incorporated, Home Depot Inc, NVIDIA Corporation, Adobe Inc) did failed to make new higher (EPS) than the previous quarters. These stocks lead S&P 500 index and went beyond it because they just report a profit, any kind of profit high or low, in time of pandemic as shown below:
Company nameEPS After(Sell off)EPS before (Sell off)
Microsoft1.41.51
Apple2.554.99
Amazon5.016.47
Facebook1.712.56
Google9.8715.35
Johnson & Johnson2.31.88
UnitedHealth Group Incorporated3.723.9
Home Depot Inc2.082.28
NVIDIA Corporation1.81.89
Adobe Inc2.452.27
Source Investing.com

As you can see in the above table, all companies failed to break (EPS) made before the Sell-off except for Johnson & Johnson and Adobe Inc. Even these two companies their EPS reported in time of pandemic still within the average of their EPS for the last four quarters before the Sell-off.

  • Companies such as Visa and MasterCard which their services did not distributed by the pandemic failed to lead the market in this stage and they are moving below S&P 500 index.
  • Netflix the company that should be one of the most companies that generated profit during this pandemic due to the lock-down made by all governments, failed to make an EPS greater than the one before the lock-down.

All these factors (either Technical or Fundamental) suggested that the up-move for the market which started March 24, 2020 is just a pullback for down-trend that started in March 18,2020 and will resume its down movement. Either way for those who already in the market investing in good companies at least from their point of view they don’t need to panic because the market eventually if either went sideways or downtrend will resume its movement to up trend and break 3300 points level and go beyond that.

For those who still have their cash I suggested that they don’t get into market until the following conditions are satisfied:

  • The market need to go down and do not break the last support point which reached in March 23,2020 which was 2195 points, and make new higher low near to that level.
  • Or the market need to go up and break the last high that made in March 19, 2020 which was 3380 points and pullback to it with failing to break it, in down move.
  • Or fluctuate around SM(200) with going up and down two times at minimum in order to make sure it is a correction phase that will end within months or maximum a year before it started moving up.
  • Also companies that suppose to lead the market should provide new (EPS) higher than the previous one in order to validate their up-movement.