Lessons from the Pros


Picking the Top

With all-time highs being achieved in the Dow and the S&P 500 indexes, the question on everyone’s mind is, “Where is the top?” Many traders know that buying stocks for longer term holds is extremely risky in this environment. What about entering shorts? We may be premature for that as well.

While teaching a Professional Futures course in Long Island last week, we were studying the relationships between different asset classes. All asset classes are related to each other. Most traders know that a change in price in the US Dollar will have an effect on the prices of commodities like gold and oil. But there are many other relationships that we can explore. Some securities have an inverse relationship, when one bounces from supply, the other will often be bouncing from demand. The biggest reason for understanding the relationships between the asset classes is to use them as an odds enhancer when we are trading.

One of my students, Mahesh, asked a great question in class, “Since there are no supply zones for the equity markets, couldn’t we look to the inversely related securities to hit a demand zone?

Students in the Stock Mastery Extended Learning Track and the Futures Extended Learning Track have been doing this for years. In their courses, they have learned how to find the securities that are related and will hit demand at the same time as what they are trading. If both securities are bouncing from demand, then a long position has a higher probability of working. Going back to Mahesh’s suggestion, we can look to the Japanese Yen charts for a topping sign. Over the past 180 days, the Yen has been approximately 97% inversely related to the S&P 500. When we look at the chart of the Yen Futures, we can see that we are approaching a demand zone on the monthly chart around 0.9200 but have not reached it yet. This is still bullish for the S&P500 until we get there.

Yen chart

US Treasury Bonds are another asset that is inversely related to the equity markets. This is not always the case as relationships can change. Right now, traders and investors see the stock markets as a high risk/high reward opportunity. If their risk appetite changes, they will switch to the safety and lower reward of bonds to protect their capital. Bond prices have been declining sharply for several months. Should bonds be seen as a cheap investment, they may bounce from a demand zone. This could draw investment money from the equity markets and send the S&P 500 and Dow lower.

Treasury chart

Of course we should not short the equity markets blindly just because a related market has hit demand. But this signal could warn us to exit longs and be on the lookout for a trend change. To learn more about these relationships and also how to identify trend changes, join us in one of our courses at Online Trading Academy.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.