I am just having some difficulty in understanding sentiment to do with pschylogical shifts (eg. Sustained breakout after stops are hit etc)
I remember in a previous lesson you spoke about the momentum bubble and when it bursts it will reverse because because everyone and their dogs are getting in without real macro / news reasons and so it’s a inflated price. I get this however, isn’t a psychological shift the same after a breakout, meaning the potential sentiment that’s being created just because a level breaks. Shouldn’t that reverse back if there is no global macro/news to back it up?
Or is a phychological sentiment shift have to be in harmony with macro etc.
I am having difficulties in seeing how a momentum bubble caused by everybody getting in thus distorting price is different to sentiment causing a decent move after stops have been tripped, just based on psychological reasoning meaning that it should not be sustained?
Thanks and really enjoying the course,
You ask a very good question! I can tell you are reading the material very well and knowing the right questions to ask.
In the stop hunting lesson, I wanted to cover all the different situations for how stop hunting or stops being tripped can be used and interpreted. One of them I call the sentiment/psychological shift. It is different from a stop cascade, because a stop cascade typically occurs much faster and the market can gap prices a large amount. Lets say there is a stop cascade and the market moves 100 pips within 5 minutes. Chances are the market gapped a large number of prices in between and did not trade at every pip level.
The sent/psych shift is different in that it is usually more gradual over the course of an hour or several hours or one whole day.
I was trying to identify and classify the area in between a quick profit / easy picking stops being tripped for 5-20 pips, and between the Stop cascade where the prices gap. That in between area I call the sent/psych shift.
The momentum bubble that I was talking about, lets take an example of a market going into a parabolic state in a major bull move. There can come a time where the rational macro forces have already committed all they can to the bullish scenario. But after that, sometimes the huge move can entice other irrational market players to enter. Now, these irrational players (they could be tech traders, or even irrational macro traders) still do have expectations attached their trades and are betting on a scenario. You can also call them “momentum surfers” or “momentum play” or “momo play.” They are just betting on a very extreme scenario to take place. These irrational players are relying on even more irrational players to come in and buy the market to push it higher. They are playing the greater fool game, because the macro conditions may not justify a huge parabolic rise, but the irrational momentum players have taken over and are pushing prices higher.
Now you may ask, if the move is irrational according to the macro environment, then why doesn’t it correct and snap back? Well sometimes, it does. But other times, the rational macro players are not crazy enough to step in front of a freight train. The rational macro players do have a lot of capital at their disposal, but they want to use it wisely. Sometimes the rational macro players do not have enough capital to force prices into their more proper alignment right away. The rational macro players realize that in order for their trades to pay off, they need to wait for the irrational news/sent/fund/macro and momentum players to finish exhausting their capital and order flow.
So, lets take an example of a stock that is going parabolic during the tech boom. In the beginning there may have been legitimate news/sentiment/fundamental/macro reasons for the stock to rise, even rise a great deal. The stock starts off at $10, and rises to $50 within a year and half. Let’s assume that was the more rational news/sentiment/fundamental/macro order flow. But if certain market participants get excited and start getting irrational, then that can unlock a great deal of “irrational capital” that was sitting on the sidelines and decides to jump in. This can cause the stock to jump from $50 to $100 or $150 or higher in just a few weeks or months. Sometimes that irrational capital is from people who are already long the market, but want to pile in harder with even bigger position sizes.
You can see this manifested when the market enters a parabolic state and the mere making of a fresh highs, or taking out the topside stops above the daily highs is enough to cause the market to get excited again and go even higher.
The rational macro players see this happening. They may even see that prices are “out of whack.” But they may not be crazy enough to go against such huge irrational capital being allocated to that particular market.
For example, the book More Money than God writes:
Because hedge funds remained small relative to the market, a bet against the bubble would come good only if others bet the same way, and a hedge fund could sustain heavy losses in the meantime.
So the rational macro players could have been riding the move up in the early to medium stages, but then decide the move is getting irrational. If they decide to dump their stock for example, if the irrational market players are strong enough, they will absorb that stock and still push the market higher.
There are all sorts of situations in the past where a hedge fund held a large block of stock in a rising market, they decided to sell it all, but even as they dumped their whole stock, the market price barely went down. This is either due to one of two reasons:
- Because the irrational macro players were piling into the long side and overwhelmed any sell order flow.
- Because the true macro value was higher, and the hedge fund sold too early.
So therefore, there are many times a bubble is forming, where a rational macro players can decide NOT to try to go against it. They can decide it is too risky. So that is why sometimes the price does not reverse back if there is no global macro/news to back it up.
This is where the old trading quote comes into play where you want to be right on the market, but be right at the right time. Being right at the right time means having the overwhelming news/sentiment/fundamental/macro players on your side, whether they come from rational or irrational sources. You just want them to place aggressive, massive trades that move the market.
Going back to your question about how a momentum bubble is different from sentiment causing a decent move after stops have been tripped.
I believe the difference lies in that the sent/psych shift can happen in range bound or trending markets. Because the sent/psych shift can last anywhere from say 30 – 200 pips or so. While the momentum bubble usually occurs in markets that are in trends, and that are irrational as well. A sent/psych shift in a particular direction can only last a few hours, or it can last up to one day or so. And it can happen in either direction. It does not require a huge trend to be in place that is irrational.
If a currency pair is stuck in a small downtrend, and an opportunistic market player sees that there are a lot of people short and stops are accumulating to the topside. If they judge that a tripping of the topside stops will not only cause 10-20 pips of movement, but also cause a whole day of short covering, then they can trip those stops and cause a sent/psych shift that lasts for a few hours or one day or so. The stop hunters don’t even have to hunt the stops. Sometimes it is the natural macro/sentiment traders that start to take profits and cover their positions, which trip the stops, thus causing more macro/sentiment traders who start covering their trades as well, just do so at a later moment in time.
If the macro forces are truly to the downside and they have not been exhausted, then they will cap the retracement and eventually cause the market to go down again.
Sometimes you have to make sure that the macro forces betting on a particular scenario are not exhausted if you want the market to continue the trend. Because if the macro forces betting on a particular scenario are exhausted, meaning they have already allocated all the capital they can, and the expectations are properly anchored in the rational macro environment, then the market may struggle to move further, until it retraces, or fresh catalysts come into the picture.
Therefore, in some cases, the sent/psych shift is in harmony with the rational macro and can cause the move (30-200 pips).
Other times the sent/psych shift is in harmony with the irrational macro forces and can cause and fuel the momentum bubble.
Other times the sent/psych shift occurs because the rational/irrational macro forces have exhausted their capital betting on a scenario and are prone to profit taking / short covering. Say for example a market that has been in a bubble and finally it tripped downside stops, resulting in capitulation sales and panic to get out as there is no significant rational or irrational macro buyers left.
Follow Up Question:
Thanks for the detailed response, it has helped immensely.
Just as a quick follow up to first question. What is the best way to determine/expect a momo bubble and secondly when and how can we determine when particular stops at a particluar level are going to cause a psychological sentiment shift. Below are my current thoughts.
1. Momo bubble. I know TA pa traders sometimes look for an acceleration in a trend etc to make a determination of a bubble or parabolic move, however I some how think this is a flawed method as you have changed my whole outlook and I thank you. Does it come back to daily habits etc to see how a market reacts. Eg. If a event caused a 100 pip move last few times and now we see 500 pip move, with stops being tripped and every man and his dog buying. Rather than the macro generating x5 orderflow we could infer its a irrational parabolic move? Especially if there are no new macro factors pushing price up? Is this correct. And if so can’t markets still be sensitive to different events at different points in times, say x caused 100 pip move last month but now it caused a 500 pip move because market was more sensitive to the single event, so in essence isn’t it also possible the increase was due to sensitivities rather than a momo bubble?
2. Sentiment shift. Can we expect a shift causing a bigger pip move if we have been in a range , price keeps bouncing numerous times thus more stops building up as opposed to it only bouncing twice before tripping. Would this be an example of a sentiment shift because of price bouncing off resistance than finally tripping a large pool and causing covering and fresh positions by breakout players, even if there was no macro news shift? Of course if we have macro and news in favour of the large stops being tripped, it could be massive. So in this example I am thinking the shift in sentiment after stops being tripped is due to the amount of times price has hit that top of the range therefore causing larges amounts of stops to build up, plus making the top of the range a psychological level for participants.
Cheers and thanks for your teachings in this field,
You ask very good questions indeed.
- Well for the momo bubble, you want there to be some sort of trend in place first. You want to see the market being moved by the rational macro forces first. In order for the market to go into a highly momo state, it needs to have been in some sort of trend first. Then after the rational news/sent/fund/macro players exhaust themselves, then the irrational forces can sometimes take over to cause the speculative frenzy and momo bubble. Usually there has be some sort of story that can go along with the speculative frenzy and momo bubble. There should be a decent news/senti/fund/macro story for the rational forces to cause the market to move and trend, then the irrational forces take over and cause an extreme pricing in of a particular scenario or expectations. Then those irrational forces rely on even more irrational forces to come in and push the market further. So the irrational forces are betting on a macro scenario as well, they are just betting on an extreme one that stands a lower chance of happening.
Let’s take USD/JPY trend up for example. My analysis concludes that this isn’t a irrational move or momo bubble. The big rally seems to be rooted in natural and rational macro order flow. The rise in risk appetite, rise in US bond yields, BoJ QE more, BoJ increase inflation target, stronger US economy, etc all have contributed to USD/JPY going higher. So that is a natural macro trend. Japan has not really disappointed the market yet with regards to the policy it has pursued. It hasn’t turned into a momo bubble yet. I don’t know when or if it will. Not all trends turn into momo bubbles. Only some of them do. Sometimes trends reverse because all the rational macro get exhausted and the expectations get repriced as the trend reverses as the rational macro takes profit and reverses. So most of the time the trend ends because the market reaches the natural “macro exhaustion point” where all the people betting on a particular macro scenario have already gotten into the market. Then once that happens, some of the rational macro may decide to take profit and reverse if they see the news/sent/fund/macro shifting.
Of course momo and extreme moves can happen in bullish moves or bearish moves. Most people know of the momo bubble because the whole world’s population and natural inclination is to be long the market. Most of the world’s savings, investments, 401k, retirement accounts, etc are usually long risk appetite betting on improving domestic and global economy to drive prices higher.
But the same thing can happen to the downside, where there is an extreme momentum move to the downside, and the market being prone to vicious short covering once the move ends.
I don’t remember the last time a really big momo move happened in the forex market. Perhaps back in 2011 with the weakening of the Swiss Franc. The last 1,000 pip drop in EUR/CHF may have been a lot of momo plays.
The big run up in gold/silver during July-Aug 2011 was a momo bubble. As there was a safe haven bid elements that was activating in gold, even though there was massive risk aversion going on. Eventually that safe haven bid macro flow, both the rational and irrational was exhausted, then they turned into profit takers and macro sellers because while the macro can also buy gold for safe haven, they can also sell gold in liquidity driven selling / risk aversion / raising cash.
Most of the money is going to be made in the rational news/sent/fund/macro order flow. The maximum opportunity set for those plays is extremely high across the financial markets. That is why I like to search for those. They are much easier to find that the momo bubble and momo plays. That doesn’t mean you shouldn’t look out for the momo bubble. You should be on the lookout, because if you are already in the move, then you can know that a speculative frenzy is coming, which would drastically increase your profits, or you can play the momo bubble as well, you just have to know when to get out.
The momo bubble is easy to play before it ends. For all you need to know is play the breakouts the normal way and the momo players take care of the rest. A lot of people make money in momo bubbles. The TA, PA traders, the moving average crossover traders, etc. The real question is can you get out before it ends? Because sometimes when it ends, it gaps against you so you have to be careful.
You are correct that the market can shift sensitivity. So when “x” events caused a 100 pip move last month, but now causes a 500 pip move, it may due to the shifting sensitivities rather than a momo bubble like you said. Just because there is a shifting sensitivity doesn’t mean that there is a momo bubble in place. There can be rational shifts in sensitivity as the macro environments and conditions change.
But yes, one way to detect the momo bubble is when you notice the market making huge moves based on small or medium shifts. So if you expected the market to move 40 pips based on the rational interpretation to the information flow, but it moves 200 pips, then that can be a warning sign that the market may be in a momo bubble. Or for example, say you only expected the information flow to cause the market to retest the highs, but it breaks out and results in a MDMM to the bullish side, etc.
A lot of depends on what the proper interpretation of the information flow is. How big should the move due to the rational macro participants? People can differ on that. Not everyone interprets the same thing at the same time, in the same way.
2. I would not say to expect a bigger pip move just because the market has been in a range. Just because price has been bouncing many times off support and resistance doesn’t necessarily mean that if the stops are tripped a big move is coming. You can find a lot of charts where there market was in a very choppy move and there were plenty of false breakouts, etc.
A: I would say, one form of sent/psych shift occur in the momo bubble we talked about above.
B: Then the other form of sent/psych shift occurs because the stops being tripped cause the natural, rational macro order flow to enter the market (these happen more often than the momo bubble. Focus on this)
C: Then the final one is where the sent/psych shift occurs because the rational macro is exhausted and prone to profit taking/short covering. (these happen more often than the momo bubble. Focus on this)
B and C, happen much more often than A. So if you are attempting to identify these sent/psych shifts, then focus on B and C.
You can detect some of the through performing the proper daily habits. Seeing how the market responds to news, and reacts to different pieces of information. So you can definitely place trades based on how the market has been responding and has responded to recent information. But you also want to make informed decisions about the near future macro as well. Just because the market may have been “acting right” doesn’t automatically mean you should place a monster trade. Sometimes the market is acting right temporarily, but a near future macro shift is going to happen to cause the market to go the other way. The best trades happen when the market is acting right and the new future macro shift happens in the direction the market is acting right. Because in that case you have news, sensitivity, positioning, macro all working in your favor.
I included a lot of nitty gritty information about stops and barriers and other things in the mastery course because I wanted to be really detailed and cover all the angles. And we went to even more detail in these emails.
Personally, I don’t usually try to go into such excruciating detail. I keep them in the back of my mind, but during most days, I try to find where the rational news/sent/fund/macro players are going to move the market. You want them to cause volatility in your favor. That is the basic foundations of the market and what I try to do every day. I also keep an arsenal of other tactics talked about above and in the mastery course to try to find other types of trades and inefficiencies. But most of your profits should come from the rational news/sent/fund/macro over the long term. Looking back into some of the top discretionary traders of the past, most of their profits over the long run came from the rational news/sent/fund/macro order flow. They were able to see things that other people did not see in the rational news/sent/fund/macro order flow and got in quicker than the rest.