Pick the Turning Points… And Win!

By: Keith Cotterill

The following is an excerpt from Keith Cotterill's Don't Tell the Professionals

It’s often said that it is difficult, if not impossible to pick the turning points in a market. I couldn’t agree more… IF you’re only using price action as your source of market analysis. But, if you combine price action with volume then you’ll be amazed how accurately you can call the turns and start trading with confidence.

The turning points in a market are simply changes in professional sentiment: from long to short; from bull to bear; from an upward trend to a downward trend.

If, for the moment, we discount any trading opportunities offered by any narrow sideways congestion, then the market presents us with essentially two options: exploiting rising prices or falling prices.

So what causes the professionals to change their sentiments and their trading behavior? Despite their great wealth and influence in the market, it is by no means a ‘fixed’ market. There must always be legitimate and cogent motives for professionals to ‘lubricate’ prices up or down.

Professionals must have a reason!

Whether it is substantial buying or selling, crop reports, economic news, weather reports, or a whole host of other factors, there are countless valid excuses for engineering moves in the market. Look at the evidence in any price chart. Prices are frequently run up and down aggressively… but only because there is a reason to do so.

Once the reason has gone, it’s amazing how prices return back to where they started.

A perfect example of using legitimate news to move prices, occurred on 20 February 1996 when all of the financials ‘fell out of bed’, with Eurodollar Futures (March 1996) contracts falling 33 basis-points, an astoundingly large slump for this market.

So what was the ‘reason’ for this abnormal drop in Eurodollar prices?

During his semi-annual Humphrey-Hawkins testimony, Federal Reserve Chairman Alan Greenspan offered little to support hopes for the easing of interest rates. Consequently, all financials fell sharply, with the threat of higher interest rates.

In the chart below you will see how the news was used to cause a sell-off in Eurodollars for one day, with prices recovering over the following three days, from where they had started their decline.

On the 20th February, Eurodollars ended the day with a loaded down bar.  The Market took the news badly with Treasury Bonds losing over $2,000 per contract – the highest fall in one day since the 5 May 1994. However, the next day saw Eurodollars open with prices rising from the start and regaining 60% of the previous days fall.

Loaded down bars are daily price bars, which open on the high and fall during the session to close on or near the lows. To suggest professional activity, a price bar must also be accompanied by very high, or ultra-high, volume. 

So what had changed in the 24 hours to claw back almost two thirds of the previous day’s fall? The opinion changed from doom and gloom, to the possibility that rates could still be reduced. The fear of a falling market was replaced by optimism.

Does this suggest that the previous day’s loaded down bar contains selling?

Obviously not. If it was selling, why did prices rally back from where they fell in just three days? I wonder how many day traders got their fingers burnt chasing this one to the down side! Now let me ask you this:

If you had been trading back then, what would you have done? By using the simple logic of loaded down bars, you would have been alerted to a likely reversal in prices and therefore, you would have been prepared to either take advantage of an up move, or close out any put options or short futures positions.