E Wisdom In Price Action

In my years of trading the financial markets, there is one principle that I believe in without exception. That principle is that price action will give a trader more information than he can find on his own. There are large hedge funds that pay millions of dollars to have information that the public doesn’t have. The only way to create a more level playing field is to understand that there is wisdom in price action.

The last few weeks have been a great example of this point. Rewind back to mid-October when the markets were tanking. The S&P 500 was down nearly -10% from its highs and seemingly getting weaker by the day. There were fears of an Ebola outbreak, Fed tapering stimulus to zero, a sharp slowdown in Europe and China, and much more. The markets looked absolutely terrible. However, in the midst of this chaos, the markets put in a significant bottom (shown below).

On October 15, the S&P 500 Index surged off of its lows and formed a hammer candlestick (in fact, every other major U.S. market did the same).  The volume spike led to a new 52-week high for the S&P 500. This suggested aggressive capitulation on the downside. From there, the markets continued to rally over to new all-time highs and a larger than a +10% rally in just 12 trading sessions.

There was no great explanation for this rally. Ebola was still a concern and hadn’t been resolved. The Fed meeting came and went as expected with an end to QE. Europe and China continued to slow and each reported disappointing numbers in their economic data. So, what changed?

On October 31 (last Friday), the Bank of Japan (BOJ) surprised the markets with an announcement of more aggressive stimulus. This was surprising because the Japanese already had a stimulus package 50% larger than the U.S. at its peak – with an economy that was only 1/3 the size of the U.S. The BOJ announced that they would, in some cases, triple the current stimulus program…a program that was already so aggressive that the BOJ was literally buying stocks and ETFs in a last chance “Hail Mary.”

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