Pandemic panic plays a huge role in the way markets move. Logic gets lost and price is frequently determined by fear. Herd mentality is widespread and unpredictable. Technicians recognize these phases as roller coaster rides and must adjust. Trend strategies often fail when panic is prevalent; thus, countertrade tactics usually prevail.

Market Phases

Markets trend, consolidate, trend and consolidate again. These phases are constant in all markets. A trader needs to identify which phase a market is in and apply the best strategy. Markets were created to facilitate trade. When a market moves in a direction and the day ranges and volume decrease, it is not facilitating trade. As volume decreases opens and closes tend to be near each other (small candlestick bodies). Subsequently, a reversal often occurs. Another type of reversal comes when the pace of a rally or decline surpasses the normal speed. This is commonly known as an overbought or oversold condition.

Technical Tools for Gauging Speed

Many analysts use technical indicators to track the speed of a move. The most popular are RSI (Relative Strength Index), Stochastics and MACD (Moving Average Convergence Divergence). When RSI or Stochastics get above 80, a market is thought to be overbought. On the other hand, a reading below 20 signals an oversold situation. One problem with these indicators is that a market may hang around that 20 or 80 level for weeks. This makes timing a reversal a tough task. In fact, RSIs are more effective when used to determine trend strength. Stochastics are more reliable when looking for a trend reversal indicator. MACD is best used to determine when a market has moved too far or fast or is wound too tight, thus increasing the odds for a breakout.

Average True Range Gauge

Traders may become more skilled at picking tops and bottoms if they are familiar with vertical dimensions, otherwise known as ATR (Average True Range). Benchmark ranges are used to identify when the speed of a move has become too rapid, thus favoring a consolidation phase or possible trend change.

Normally, I prefer to use a 14-day ATR as an overbought/oversold gauge. If a day range spans more than 175% of the daily 14-day ATR in a 24-hour period, it is considered too quick. In this situation probabilities shift to favor a period of consolidation or change in direction. Another indication of a pace problem (overbought/oversold) is to identify when a market has moved the length of an average week (9-week ATR) in a 48-hour period.

Pandemic Allowance

When news that the new variant Omicron was spreading, panic ensued. Treasuries rallied while equities and oil fell quickly. Equity indexes dove the length of an average week in just a few hours. Crude oil dropped twice the length of an average week in just one day. When extraordinary moves become frequent and unpredictable, many technical indicators and typical gauges lose effectiveness. Current day ranges are far above the standard because panic reigns. Therefore, an adjustment is required.

When volatility rises so do risk and profit potential. Thus, a contrarian approach or neutral option strategies should pay. Implied volatility levels are high, so credit spreads should work best as the dust from the storm settles.

During this volatile time, I refrain from relying on my typical overbought/oversold signals. Instead, I am willing to countertrade a move if the market moves the length of an average week over a 24-hour period or if it moves the length of an average month in a 72-hour period. This recently happened with crude oil.

If you prefer a contrarian approach when trading or if you prefer to sell option premium, search for markets that are overbought/oversold. Option traders who prefer to collect premium should hunt for markets that exceed normal speed limits. Good timing can have a huge impact on profit and risk. Recognizing severely overbought/oversold signals will enhance your odds of picking off extreme highs and lows for both entry and exit trades.

John Seguin, Market Taker Mentoring