- New Science in old markets -

Whipsaw danger – be patient

As reported often here, we have been seeing multiple compression signals in various financial markets and some commodities too. It is worth repeating that these are times of great danger for traders as compressions signal a complete lack of consensus at all time frames. Confusion reigns and this condition can take some while to resolve. There is s considerable risk of false breaks, as shown in these two recent equity index examples. We always advise waiting for a closing break of a compression before taking a view and even that doesn't always help, as the first chart of the S&P shows. It is even more dangerous to make a decision based on an early break of a compression, as the second chart of the AEX shows - it appeared to break up early today but has now fallen back into the same compressed area at 2.pm London time as I write. No break at all.

S&P, AEX comp danger

 

The same thing has been happening in government bond markets. These are tightly constrained by opposing forces and so trading ranges have formed in almost all of them. Compressions have been appearing for weeks in some - the BTP shown in the second chart has seven in the last 5 weeks - and now are showing up in the US ten-year too:

Notes, BTP comps

The remedy to all this danger is patience. The risk of following a break is high and whipsaw is the probable result until the 'real' break occurs. Accordingly we advise waiting until that break has clearly happened and then waiting for the 'return movement' that almost always follows.

Compressions act as 'attractors' in the scientific sense of the word. Repetitive behaviour caused by feedback usually settles into a rhythmic or pseudo-rhythmic pattern, as described in our videos. This means that certain paths of motion are re-visited more than others, and in freely-traded auction markets this takes the form of price areas that seem to act as magnets, alternately attracting the market to them and then repelling it away. This has long been noted by observers and is part of market folklore but it is only by including complexity mathematics that a proper explanation can be found. So this is how markets behave after compressions - first there is a sharp move away from the compressed area and then (usually) there is a return to it, followed shortly by a resumption of the original move. As ever, we can't usually tell which way a compression will break unless we have another good reason for a preference, so it is good practice to wait for the break and then take a position once the return to compression has occurred. In current circumstances, where extraneous influence on prices means that compressions abound, we cannot even tell when a break will occur so this will avoid whipsaw.  As we have written here, we do have a preference in the present set of circumstances for an eventual upward break in stocks, but this is not certain.

In the meantime, trading the range is also risky (that 'real break' can occur at any time) but is probably the only available course of action. These trading ranges are not so well-defined however so be very careful.