Currency In Focus: Analyzing and Trading Fear

Did you see the cover of The Economist last week?

Inside a picture of a black hole is printed, “Until politicians actually do something about the world economy… BE AFRAID.”

Wow! When a theme makes it to a magazine cover, it can be considered a strong sentiment event. Fear has become so pervasive that it’s literally front-page news.

But it’s important to gain some perspective on these emotionally-saturated headlines. Essentially, the fear is feeding on itself. Investors read the headlines, get scared, start selling — leading to more headlines that people should be scared and start selling.

So instead of filtering the market noise, the headlines just add to it. This is quite limiting in providing what philosophers call “veridicality” — the ability to genuinely and accurately perceive an event.

That’s why effective trading requires looking beneath the surface of market fears and seeing if we can rise above a verbal perception of market patterns. I do that every week using a variety of tools. They shape Strategic Currency Trader’s trading analysis and can enhance your ability to face and trade through market fear.

There are four I consider the most important: Parabolic patterns; price cycles; volatility; and volatility smiles.

Today I’d like to share the one with you — parabolic patterns.

In the simplest terms, a parabolic curve is a rapid change in the price of a security, up or down. When we see a parabolic curve, we are looking at the most reliable signature of fear.

And we don’t have to look far to find a recent example. It can be seen in the price action of the USDCAD.

As you know, Canada’s dollar, affectionately called the Loonie, is tied very closely to the price of commodities. So the headlines from Oct. 4 tell the tale:

The morning started with oil prices falling below $100. That got people’s fears up, creating an extreme emotional reaction — with people getting out of the Canadian dollar as quickly as they could.

Then the news became less dire, and by the end of the day, news turned positive. As it flowed to investors, so did sentiment. Investors started feeling better about the Loonie, pushing its value up sharply.

These severe emotional reactions created a classic parabolic pattern.

Looking at the chart reveals a key feature of the parabolic pattern — it is highly predictive of a reversal. Whatever their cause, these patterns can’t hold too long. At some point, the fear of losing profits takes over and creates a wave of selling. Once it’s sold off enough, hope, and potentially delusion, takes over, and people buy in.

So whenever you see a parabolic, no matter if it’s on a five-minute pattern chart or a day chart, get ready for a sentiment reversal that leads to a subsequent price reversal.

Fear Is Our Friend

I hope you have gained some insight into the structure of sentiment in the price action. With the mainstream media contributing to investor anxiety, the dominance of fear is predictive of stormy market conditions.

However, it is not predictive of losses. Market turbulence translates to trading volatility. The Loonie and oil had huge sell-offs in response to major uncertainty and fear of global recession. Their parabolics and surges set up conditions for next week’s action. Meanwhile, the DAX and other indices continue to follow sell-offs and surges that are becoming cyclical in nature. And once again, binary options are the versatile tools that calibrate well to these predictable patterns.

In my view, fear is our friend and is very actionable.