Thinking Beyond the Irrational

THE CYCLE OF THINGS - Everything in life is cyclical. Of course, this extends to markets as well, and understanding this fact is critical if you want to have a real chance at trading. I say this because there's this never ending circle of a market trending in one direction and getting to a point where the trend has been so strong, that the euphoria for the market reaches levels that no longer even consider the possibility the trend will ever change. But as is always the case, things do change and almost in an instant, to the point where the market doesn't even remember why it had felt so strongly about the trend that is now a fleeting memory.

cartoon oct 24

TWO EXAMPLES - Now this isn't to say that knowing this fact makes the task much easier. We all know full well trends can run and run and run. This is what inspired the famous saying that markets can remain irrational longer than you can remain solvent. So the timing of things is where one needs to be sharp or else run the risk of going completely mad. I bring this up today because I have two examples on my mind. The first example is a recent one that is now seeing this cycle play out. The second is one where we're at the point where no one thinks the trend will ever end. So let's break em down.

THE LOONIE - The first example is the Canadian Dollar and the rally that we had seen in the Loonie since May, which resulted in USDCAD sinking by about 20 big figures and over 10%. As the USDCAD rate got down towards 1.2000, all of the talk out there was about how the Canadian Dollar would only go higher. And yet, we have since seen a big reversal of fortune for the Loonie. Since hiking rates consecutive times and talking up the outlook for the Canada economy, economic data has been anything but supportive, while sentiment towards the US Dollar has come back around. In September, the Canadian Dollar could do no wrong and now, just weeks later, the picture is a whole lot different and the currency could very well be headed for more pain.

STOCKS - The second example is the US equity market. Now this one has been intense without question. It might even be the most intense rally I have seen as far as this goes, with the uptrend calling out for reversal a number of times in recent years. My strategy as always, has been to let the market come to me and I have done exceptionally well, taking shots at fading extreme moves here. But in 2017, the run has continued and this has left me sitting on an out of the money short position. However, the important thing to note, which I can't stress enough, is that even though we have seen the rally continue, there have only been a few times where we've seen that euphoria kick in where it feels like the market will never stop running.

The recipe for good trading is conviction and discipline.

RIGHT NOW - I believe we've moved back into this euphoric state right now and with that said, I have started building into the short position as per my strategy at the outset. Technically speaking, when you have a market that is tracking at severe overextended levels on a medium and longer term basis, it doesn't mean we should expect a reversal at any moment. But now, in recent days, the shorter term chart has rocketed higher, leaving us with across the board extension and into another phase of euphoria. From my experience, these are the times when we will either soon see a period of extended consolidation, with the market taking a rest, or an intense reversal to the downside, at least for a number of days.

INTO THE STORM - So right now, the stock market that has been able to do no wrong, has ramped up into the mode where the market is saying it will never do any wrong. This is the time to try and take that next shot. If you're careful and you do it the right way, the reward can be huge. As a reminder, I had taken shots with USDCAD on the way down and had to step aside after it didn't work out. But I kept with it and hit a very nice long that yielded a nice return earlier this month.

TAKEAWAY - The important message and takeaway from this update is that when you trade, you need to be bold and brave and ready to take risk, knowing that things always have a way of turning. But at the same time, you also need to be smart about where you pick your spots, disciplined about the risk you're taking, while accounting for the types of scenarios where something can move in one direction for a longer period of time than most would expect. I like to think of it like this.....The market may remain irrational longer than you can remain solvent, but if you expect, accept, and welcome the irrational, it won't even feel all that irrational, and ultimately, this will give you that edge to keep at it and do well over time.

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