Tharp's Thoughts #705, October 2014 page 1

Rich Man’s Panic?

by Gabriel Grammatidis

Just two weeks ago, the S&P 500 fell 150 points (or 8%) in just five days. Some stocks had some

scary price gaps and there was a surge towards bonds as a flight to safety (see below the Daily

S&P and 10y US Treasuries).

On Wednesday, October 15 especially, there was some “panic in the streets” and many people may

remember that morning with some fear. Only a few weeks previously, the market had hit a record

high but then the market dropped along with a sharp and sudden rise in volatility.

Did you hear the market news on that day? Did you have any long equity positions? How did you

feel?

Growing Uncertainty and Risk

The financial markets have benefited for a couple of years now from the sea of liquidity provided by

central banks’ easy monetary policies. This liquidity has lifted all boats and in particular, the equity

markets – until this month. You may ask: what is the reason for all this uncertainty and increase in

risk? And why do many investors suddenly feel a bit uncomfortable when they think about the

capital markets? When everyone has been sitting on the same side of the boat and now they

suddenly change their minds about where they want to be sitting, the danger of overturning

increases.

Indeed, the easing of monetary policies by major central banks around the globe supported

economic recoveries coming out of the global financial crisis. Despite definite economic

improvements over the last few years, many countries are still struggling to get back to solid

economic growth. And now, monetary policies seem to be diverging more and more on a global

scale:

1. The Fed in the US likely to taper QE (i.e. Quantitative Easing or buying own government

bonds) to zero (decision on 29th October).

2. The Bank of Japan is having difficulties creating inflation and is likely to increase their

efforts at QE.

3. The ECB in Europe, threatened by deflation, is finding reluctance for QE from member

states and is currently being held “in the box” by its regulations.

Tharp's Thoughts #705, October 2014 page 2

Benefiting from Macro Volatility

This increasing divergence among the largest central banks is creating tensions that will appear as

eruptive increases in volatility in major asset classes. This forming background of macro volatility

in the global financial system will likely produce sharp surges and sudden drops in equities, bonds

or commodities. On the other hand, the growing risk in major asset classes from this macro

volatility leaves one asset class that will definitely offer profitable opportunities for the foreseeable

future: currencies!

As Van likes to say, “Crisis implies opportunity”! Right now, it’s plainly easy to see clear

opportunities in Forex trading and investing.

Over the last couple of months, we have seen strong and consistent trends in the currency

markets. Just have a look at the Daily and Weekly chart of the EURUSD and see how well it has

been trending since May:

Currencies vs. Equities, Mid October

The most recent “Live Forex Trading” workshop held at the Van Tharp Institute just happened to

fall on October 14th and the 15th — with the latter one being the most volatile in the equities

markets recently.

So, how did the trading go during the live trading workshop? It went very well on both days but let

me focus on the group’s work of the morning of the second day when so many markets moved in a

big way.

At 08:30am on the 15th, we were calmly observing the markets when important news was due to

come out that could create some volatility. The three systems I teach in the workshop have an

edge in any liquid and non-gapping market so we monitoring the major currency pairs, the TY (10y

US Treasury notes), Gold, the big US equity indices and the German DAX. We were watching the

charts closely on different timeframes — 4h, 1h, 15min, 5min as well as 3 and 1min bars. We

were looking for setups for the three systems learned in the workshop in the days prior.

After an initial surge of volatility and large price swings in many markets - including FX, we found

several good setups and started stalking several specific low-risk entry points to ride the trend in

specific timeframes. Like the day prior, the systems delivered a good number of trades and a very

high percentage of winners.

Tharp's Thoughts #705, October 2014 page 3

On these two days, the three systems offered numerous setups and 16 winning trades (out of 18

trades total) with a total R result of +21.8R. Most of the signals came from the 3TMA system which

tends to perform best in strong trends among the three systems I teach at the workshop. Here is

the summary trading log for the Live Forex Workshop:

Does that look to be too good to be true? Please remember, by their very nature, currencies tend

to trend. When you use systems with an edge in trending markets, you can benefit greatly — as we

did over these two strongly trending days.

As an example, have a look at one short trade in CADCHF (60min chart) that came from the 3TMA

(System 3). We got a nice, low-risk entry at 10am (4pm European time as indicated on the chart).

We were able to run it during the day, took some profits to hold the position overnight, and then

got stopped out the evening of the next day - result +2.7R.

Tharp's Thoughts #705, October 2014 page 4

In addition to the short term trades, we were able to find some longer-term low-risk setups that we

would stalk after the end of the workshop. One of those, GBPAUD on monthly bars (below),

triggered an entry signal for a Busted Long trade on 23 October. This longer term trade should

develop nicely over the next months to come. It’s an example of how certain system’s edges can

be used in multiple timeframes.

Tharp's Thoughts #705, October 2014 page 5

A Cloudy Forecast?

What are equities going to do? I don’t know, they may calm down or get more volatile. What are

currencies going to do? In this current market environment I have a strong belief that they will

keep trending nicely. What are your beliefs about the various asset classes? How do your beliefs

about different asset classes affect what you trade and how you trade?

Think of the sea for a moment — multiple forces from nearby as well as from a great distance

affect it. Differences in regional air pressure systems can create ripples or small waves on the

surface. Big waves can be caused by either local storms or from energy stored in deep water

waves from weather systems a thousand miles away. On calmer days, most sailors can go out and

enjoy their time on the water. On stormy days, however, only the most experienced and bravest

should venture out. Pay close attention to the conditions around you — otherwise you might get

surprised. A capsized boat can be very painful or even deadly so be sure to choose the right boat if

you want to go out on the water.

If you are long equities right now, you still might make good money if the market moves sideways

or even into bull territory again. Should a volatile bear market get started, however, you could

trade equities on the short side as well but you will probably need to decrease your holding period

to intraday. I remember watching the amazing volatile up-spikes during the bear market of

2008/2009. Those days hurt many short traders. Not many people or trading systems can handle

that type of volatility very well.

Regardless of how volatile the equity markets become, however, the FX market will continue to

offer great trading conditions for years to come. The central banks’ diverging monetary policies

create tensions that translate into smooth, consistent and trending currency price charts. I

certainly prefer sticking to this kind of trading. Think about it yourself - how can you add this asset

class to your trading portfolio? Keep Forex trading in mind as you watch the equities.

I hope to see or hear from you soon.

All the best, Gabriel Grammatidis