Jim's Chart
of the Month



Book: Kane Trading on: A Totally New 5-Point Pattern
July 4, 2010 Commentary (monthly edition)-
I'll start the same as last month's commentary, and the previous month's commentary. I'll just save this as my standard 'cut and paste' intro from now on out: "Wow, what a month. I know I shouldn't be at all surprised by anything I see in any of the markets, but I still am. Maybe I'm just a little slow to accept the surreal..." One look at what gold did, and the Euro, and the ramp in the Swissie, and the mini 'flash crash' in C, and on and on, and it is clear these are simply wild times. I am to the point where nothing would truly surprise me. I may act surprised, and even have a surprised look on my face, but I can't imagine saying 'Well, I didn't see that coming'. So, who knows, maybe that will be the intro for my next commentary, me eating those words. Still, it would be a tough chore for the market, since I'm the guy expecting a full global reset at some point...
I'll cover a one item of business real quick here, and then we'll get to work. I really enjoyed my new experiment, taking a week or so 'off' from everything but the market. No e-mail, no book shipments, no students, nothing but the market and 'free time' to go outside, work in the garden with the better half, shoot a round of golf, watch television, whatever I wanted. It was better than I thought it could be. My biggest concern is how addicting it is.
So, since it went so smoothly, and I simply shipped out the orders I found when I checked my e-mail again, I plan to do this as my new way to attempt to balance my life, at least during the nice weather of the summer. I will do this again maybe starting next weekend, and again some time in August, depending on when the urge strikes me. Who knows, maybe even in September, too. I'll post notes on the books and eArticles pages when I'm taking a break, and hopefully on the What's New page. So, again, if you try to e-mail me and don't get an answer, check any of those areas to see if I am taking a break.
As my regular readers know, my commentary is divided into two sections. The first part is the intro, where I commonly talk about some aspect of the economy or trading from a 'fundamental' perspective. That is then followed by the 'technical' part of the commentary, where I do the chartwork. I probably could just do the latter and have many happy readers. It seems, though, that I get a lot of positive feedback for the intro work, and it gives me a chance to vent and also to introduce some of my new and totally 'unique' ideas and thoughts. So, for now, I'll keep this format.
For today, I want to briefly discuss another one of my new concepts, this time regarding the topic du jour, deflation. Recall awhile back I coined some possible new terms for conditions where we may see both deflation and inflation. This was somewhat analogous to the term that was coined for an environment where we have both a stagnant economy and inflation (something that was unfathomable before that): stagflation. See my write-up from June '09 for my new terms and such. What I was looking at was the possibility for another new set of conditions.
Right now I am studying this deflation/hyperinflation argument. Most of the people I respect are falling in line with my latest viewpoint, and that is deflation now and then hyperinflation in very short order, with little advanced notice. As I explore this topic with various people, one of the arguments I get is that deflation is unlikely with the current 'leaders' because money printing/monetizing will go to whatever extreme is needed, without bounds, to stop it. I think this may be true.
As an example, I think the Fed will announce any day now a new quantitative easing (QE) on the order of $5 trillion. Perhaps it is imminent, or perhaps it happens when the S&P hits the magical 'scare area' of around 900. I was telling people way back how I feel the Fed will go to $10 trillion on their balance sheet if need be, and that that was the second 'craziest' thing I've ever said with regard to the market. About a month or so ago I think it was I saw a statement from the Fed that they see the upper end of their balance sheet at $8-$9 trillion (currently it is just over $2 trillion). Now, if they say $8-$9 trillion is doable, then $10 trillion also possible, I'd think.
The point of all this is that if the famous article that generated the nickname 'Helicopter Ben' is a true indication, how could there be deflation if money printing is literally unlimited, and the willingness to print is unbounded. Theoretically, there couldn't be deflation. Then in comes Jim, with a 'crazy' theory that surely wouldn't pass muster with any economists. Yet I wonder if it is true. Hence, I decided to post it here, to make it public and get it on record.
I recall how 'crazy' people told me I was when I talked about the entire financial crisis in great detail well before it got started, complete with details, names, orders of events, and so on. My confidence in my 'crazy' theories got a boost when it pretty much unfolded as I had suspected. So, I'm always willing to look at my 'crazy' theories when they unfold in my imagination. Let's look at my latest one.
To understand this concept I first have to explain the difference between 'price' and 'value'. Let's look at a stock that is about to undergo a reverse stock split. Let's say the stock is trading at $10, and is going to reverse split 10 for 1. You have 1000 shares. The next day you have 100 shares, and it is trading at $100. This is something we see a lot more of nowadays (albeit usually with stocks trading at say $1) to keep a stock trading on an exchange, or to meet minimum requirements for it to be held by certain entities.
Now, what happens to the price? It goes up. Should you be jumping for joy as an owner? Not really, as the value of your entire holding has not changed at all. But the price went up. One could ask, isn't this inflationary? Prices are rising after all. No, because the value is the same. Let's look at an example where the stock jumps way up on some 'great' news, like a takeover. It closes at say $10 and opens at $20. But you still have the same number of shares. The price rose, but so did the value of your entire holdings. This would be 'inflationary'.
We are looking at price vs. value here. I feel one needs to take this into account to determine if there is any inflation (or deflation). Now, let's apply this to my concept. Here's the theory: you can still have deflation even with essentially infinite money printing. Wow, now is that not only 'crazy', it totally goes against all commonly accepted economic theory. And I feel it does because all these economists look at price, and I'm looking at value. Keep in mind, all of what I am presenting here is simply my opinion.
So, say we have an item, a widget, and it costs $100. As deflation sets in, the price drops to $90, then $80. This we cannot have, they say. There are factors in place that are decreasing the value of the item, sometimes even below production cost (which is one reason why deflation can be so devastating). Oversupply, lack of demand because of poor economic conditions, highly restrictive credit conditions, tight money supply, and so on can contribute to the decreasing perceived (and therefore real) value of the item. So, to solve this, let's print some money and see what happens.
Let's say we increase the money supply 25%. In doing so the price of everything promptly increases by give or take 25%, since each dollar is now worth 80% of what is was before (we see this every year as the buying power of our dollars is steadily eroded on a smaller scale through 'inflation', which is printing more and more in order to steal our savings slowly). If the deflation was say 18%, now the net effect is still a little inflation. The prices are rising now. But think about this. The prices are rising, but is the value?
You see, I feel that value is an inherent characteristic, and it is not substantially affected by currencies or their state of printing. That inherent value has to do with supply and demand, and various fundamental considerations, including attitudes (which can shape demand). No matter what the price is (since price is, after all, just a number that only depends on the currency and how it is denominated at any given time), whether it is inflating or deflating has to do with the inherent value and how it is changing over time.
Recall how many people would talk about how absolutely silly it was when a stock split was announced in the dot.com days, and a stock would promptly go up 50%-100% in short order (I recall one stock that was up over 100% before it actually did the split, so post split it was actually higher than when the split was announced!), given the split wasn't truly doing anything as far as the value. The true, intrinsic value didn't change at all, not one bit (I'll discuss in a minute the psychological effects of the rising prices). If money is printed and the price changes substantially, does that change the inherent value of the item?
I propose that if the item is under deflation because of fundamental conditions, it will deflate regardless, even if you inflate the money supply by a billion percent. Let's go back to our example. Let's say we have a 10% deflation because of an inherent value decline. So a $100 item would drop to $90. Instead they print money like crazy, and increase the money supply 25%. What would be the price of the item? It should be $125, right? No, I think it will be $112.50. That's the $125 it jumped to for the change in the value of the money, and then to $112.50 to account for the inherent loss of value that the deflation is causing.
You see, the pressure on the inherent value of the item doesn't change because money is being printed. This doesn't 'solve' a supply and demand issue. So, on the surface to the uninitiated the price seems to be rising, like a stock after a reverse split, but the value doesn't change because of that reverse split. So, the item is 'deflating' as the price is rising (this is not to be confused with my earlier terms for inflation and deflation at the same time, as that was referring to some items inflating while other items are deflating). Deflation hasn't been stopped at all, although all the main stream media and all the analysts would say it has.
What is needed is an increase in demand, less supply, and so on. And in most cases where way, way too much overcapacity was created, this takes time. Time they don't want to give it. They want to solve problems now without addressing the real issues. But, alas, there is some possibility that there is somewhat of a method to their madness. This method comes from perception. Just like the insane movement in stocks that announced a split, and the following dog pile on mentality, not only did the price rise, but the value wound up rising, too (well, the value from a standpoint of the total 'purchasing power equivalent' of the investment, not the 'true' inherent value).
This may also apply to all this money printing, at least for a short while. People may see the rising prices and dog pile on, causing further 'demand', just like when crude went nuts and went to its bubble highs. And all the money sloshing around does tend to find its way into assets, and hence 'artificially' increase demand, which then translates to an increase in value (inherent 'inflation'). So, the possibility exists that this could reduce the deflationary tendencies. But, like the demand for houses during the bubble, or crude during its run up, it's not 'real' demand in the sense of it coming from 'end users', and hence I feel it will only cause more problems, and much deeper ones, down the line.
My point in all this, my theory, is that a ton of money printing may decrease deflation via changing people's perceptions and creating artificial demand, but that's not a given, deleveraging and demand destruction, combined with huge oversupply may allow deflation to continue on in the face of almost unlimited money printing. To me, it surely is possible, and isn't something that is even being discussed. Who knows, maybe there is something to this theory, and maybe not, but shouldn't we at least be looking at it? Imagine if they printed like crazy and a loaf of bread cost $1 million (much less, I think, than it cost in Zimbabwe, where I saw they use $100 trillion notes), and we still had deflation…
Okay, let's move on the the second part of the commentary, the technical part, the chartwork. I had so many choices I was just tormented trying to decide what to cover. That gold drop (and some still argue that the gold market is not manipulated...), the Euro explosion, the Swissie rise, crude's steady drop, the quick drop right before the close on Friday in the ES, and many more things I could mention. I was just about settled on doing the ES drop, complete with time-stamped quotes from me from the forum, when I opted for the Euro explosion. I finally decided based on mixing it up. We had an intraday ES example last time, and all the market layout we will be looking at is also ES, and I want to keep with my idea of showing more variation. So, once we cover the market's current position, the Euro it is.
We'll start with where we left off last time with the ES continuous contract, on the daily chart.

Chart 1
Source: QCharts.com
I marked the chart with one of the scenarios I thought was a high probability. The ES rolls right down, right to the confluence of upsloping lines, downsloping line, and key Fib area. Now, looking at the chart, with all the volatility, you can judge about how much tolerance, based on the previous action, that I would be expecting to see in an area (and keeping in mind this chart is just a 'framework'). Hence, anything within that tolerance near my green marker would put me in a position to drop to a lower timeframe and 'go to work'. But, alas, the market likes to try to fool as many people as possible...
Let's look at the same chart, with a bit more data, current as of this writing, to see what it did.

Chart 2
Source: QCharts.com
Instead of the swift move down that the area seemed to draw it to, it decided, instead, to form an ABCD, and then roll hard and sell almost relentlessly. This had it moving further to the right, which spread the nice line confluence out a bit. Still, it headed right for the Fib grouping area and the downsloping line. The ABCD, as it set up, was very obvious to me. Although it by no means 'had' to play out, it looked to be the most probable scenario in my mind. And play out it did.
So, did this initial scenario I posted help me out at all? I think it did. I can only post one or two scenarios in here, in this limited venue. My trading style, my methodology, is very dynamic. It takes into account all the new information that the market gives as it unfolds, and I develop new scenarios with that information. Notice here how as it rolled over from the area of the first chart, it stopped dead on that same Fib grouping level, and started to bounce.
As soon as I see that happening I take it into account, and look at other possible scenarios. I adapt to the new information, as I play detective and try to figure out what this thing is doing, what it is thinking. In a way, it's almost like tracking an animal (or a person). Reading the clues, trying to figure out what the most likely scenarios may be, hoping to gain an edge of some sort.
Once the ABCD forms and starts to trigger to the downside, then I can do new work, create new lines, do additional Fib work, and look to see where new areas may be forming. This chart still gives me the approximate area I want to keep an eye on, but further refinement can now be done. And I also have the higher 'context', which shows the importance of the downsloping line in the 'context' of the three primary Fib areas I outlined last time.
Let's jump up to the weekly chart, as we left it last time, and look at those key areas I showed.

Chart 3
Source: QCharts.com
Here's the big, key, overhead area that I showed that I thought may have ended the 'bull' market (read that manipulated taxpayer dollar induced bear market rally). As I said, maybe it did, maybe not. With the willingness to do QE up to $10 trillion (maybe $100 trillion???), can this really go down? Maybe not. At least not until the entire system unravels. But, if it did manage to go down, here are the levels I'm watching. I'll watch how it gets there, and then form some potential premises to trade off of. Notice how the first level here coincides with the lower level on the daily chart. This is where we left off.
So, in combination with the daily chart above, and keeping in mind this is all just a 'framework' (because I can't show it all in here or it would be just too cluttered, and take more time than I have) and that I have more to go by on my working charts, you can see why I am not too concerned on the daily chart that it didn't like the plunge right down scenario, and instead did an ABCD first. That's the real world.
Most of the time, I think, it doesn't do the scenario you'd like to see the most, it does something else. For me, it's all about being adaptive, flexible, and willing to go with the current flow of what is unfolding, always adapting the chartwork to what is happening, not trying to force what is happening into a rigid chartwork scenario. To me that's a recipe for disaster.
I'll add some data onto the chart to bring us up to the time current as of this writing, and I'll also add on that downsloping natural median line set from the daily chart.

Chart 4
Source: QCharts.com
Now, what looked 'way off' the mark on the daily chart looks dead on on this chart. That's why I don't get too 'nitpicky' when looking for areas. Sure, it's great when you have a pattern, multiple lines, and multiple key Fibs all hit, with time factor, and it goes straight there and reverses dead off it, and I've surely seen this, but many, many other scenarios also unfold, and for me it's about using the methodology, the techniques, to attempt to gain some small edges, not wait around for 'perfect' scenarios to unfold. I try to use what the market gives me to put together enough to be able to 'go to work'.
Now, let's look at this based on where it is now. This is the first time I can recall that I have three very clear, very key levels and they are all lining up with big 'round numbers', in this case 1000, 900, and 800. It's just something I've never seen before. I know the levels everyone else is talking about, like 940, 865, and so on. I've got a lot more detail, and all my linework, on my working charts. I have to see what it does from here, and adapt and modify my work as things unfold. Maybe it wants one of those lower levels, maybe not. Maybe it goes down and reverses between them. I have to see what develops.
These are areas to watch, but they are just Fib levels, no patterns, no lines. And, looking at where it sits right now, maybe it's done going down. Maybe we get a QE program over the weekend and it goes straight up and the bear hasn't really come back. It sure is overdue for a bounce, and what an area to start from. I don't know, and I don't feel I need to know to trade. I don't have to predict to trade. I just need to figure out some scenarios that I think give me an edge, and let probability run its course. That's my belief, anyway. Make sense?
Let's move on to that Euro, on the continuous futures contract, 240-min, all-sessions.

Chart 5
Source: QCharts.com
After the Euro just gets hammered into oblivion, it finally starts to catch a bid, likely short-covering. After rising a bit, I see an ABCD start to shape up, for further upside continuation. I post a note on this in the KT forum. Note here the corrective look to the BC leg (an ABCD), something I always find to be an additional plus to the setup. I also feel there is an ABCD in the BC leg of this ABCD. So far, so good. Time to do some work. In actuality, I start the work as soon as I get a rollover off what may be a C point. For me, spotting potential ABCD's in real time is about the easiest thing I do as far as looking at charts. Not all fully go into ABCD's, and some don't stop at the potential D point, but seeing the potential ABCD shortly after the C point forms is not even close to being on my list of challenging aspects of the methodology.
I only mention this because I have seen forum postings at various places I have checked out over the years and seen people mention ABCD's are great, but how do you spot them in real time. Well, if you know where the C point should form to meet your preset criteria, then every time you see it hit that area and then roll over, there you go. It's not complicated, and it's not difficult, in my opinion. And if you can't do that, then just wait until you see a full ABCD already formed and do you work real fast. It's hard to miss an ABCD when you pull up a chart and it looks like the above. I see them pop up just like that all the time.
I'll add a slew of Fibs on there, all from obvious swing points. I won't add on all that are possible, just enough for the point to be clear.

Chart 6
Source: QCharts.com
The Fibs are grouping exceedingly tightly, in my opinion. The area is clearly defined. But, are there other, just as tight Fib groupings? Yes, absolutely. Lots of them? Well, you'd have to define 'lots', but yes, plenty of them all the way down the chart. Here's where non-Fib people say that Fibs are then not of any use to them. Well, I agree 100%, there is a Fib at every price level on every chart, just as there is a line at every price level on every chart, and a lateral support or resistance at every price level, and a moving average or an indicator doing something special at every level. But I'm not looking to trade off a Fib level, I'm looking for multiple techniques from essentially totally different concepts to point me to the same area. I'm looking for agreement, confluence, synergy. And the trick for me is that the ABCD can't complete anywhere on the chart, it can only complete, within the parameters that I use, at a few specific spots.
So, if one of the Fib groupings hits there, too, and then some lines form a confluence there, well, three completely different techniques all seem to point to that area as a possible area of interest for me. I have a potential synergy there. Now, if it goes right to that spot, and then reacts off it and gives me a confirming entry trigger, well, I feel I may have an edge there. There is still price action reading, 'context', management skills, and so on, but as far as forming the potential trade area (PTA), that's how I look to do it. And you can see, as I say to my mentor students, once you understand the methodology the question of 'which Fibs of all the Fibs' will not be answered, it will cease to be a valid question.
Let me zoom out a bit, add on multiple lines, and we'll discuss that.

Chart 7
Source: QCharts.com
So, I have an ABCD pattern, and I now have a strong Fib confluence. If I can get some lines that fall into the area, then I have three different approaches hitting in the same spot. Keep in mind, I do not 'curve fit' things until they come together. I have very specific ways I do things, and that varies little from issue to issue, setup to setup. I apply the same approach, and if things come together, great, and if not, I move on.
If I 'curve fit' the setups then I don't feel there would be any real edge, and one would quickly come to see there is no edge. Again, I can't 'prove' that my methodology, or any form of technical analysis, has any edge, I can only say I believe it to be so. Everyone should do their own due diligence and study anything they may plan on using and draw their own informed conclusions. Now, moving on, I added another line on there, in thicker red, under those swing lows. I like lines like that. Maybe they are so useful to me because many people see them.
Everything hits right in my area, so now I have three very key lines coming into the same spot at the pattern and the Fibs. If I get a reaction and trigger, then I become more interested. No trigger, no trade. If it crashes right through, and many do, no problem, lines are cheap, on to the next setup. Before we see how this played out, let me do an aside for my mentor students, who surely looked this one over in great detail, and perhaps struggled a bit. Isn't it curious the final choice of lines, given the approach we usually use?
Let's see what this one did, current as of the time of this writing. I'll drop down to a 60-min, all-sessions chart, zoom in a bit, and thicken up the red median line. I'll also add a few other things on.

Chart 8
Source: QCharts.com
The Euro just exploded off the area. You can clearly see the monster Fib grouping with all those lines, the thicker red median line, the blue upsloping lower parallel, and that downsloping red trendline. The Euro goes right to the heart of the area, and what does it do? I highlighted it with small green hash marks. It puts in an inverted 'head and shoulders' bottom. I put a 'neckline' on there in gray. It breaks above that, comes back in to 'test it from above, then rockets up.
To me, this is a classic 'Wave 1' type of a move (and the little move that formed the second shoulder, that would be a classic 'Wave 1' of lesser degree, of the bigger 'Wave 1). It then pulls back again, right back to that same line, in what looks like a classic 'Wave 2' to me, and then the real fun starts, as 'Wave 3' gets under way. (Now, as I have said many, many times, I'm not a strict Elliott guy, I only use the aspects from Elliott that I have found to be useful to me.) Regardless of how one wants to count this, up to here or after here, the Elliott aspects served me well in assisting my analysis.
The point is, from a price action reading standpoint, and an entry standpoint, look at some of the things the Euro did, the clues it gave. It really doesn't get too much better than this, as far as I'm concerned. This move was very sharp, but it wasn't unexpected to me. And 'Wave 3's' can be extreme, so I don't consider this move all that extraordinary when viewed in this 'context'. It all looks like just another day at the office to me. Maybe the new, wild, crazy, world of the 'flash crash' office, but still just a day at the office nonetheless.
Okay, folks, that's it for me. I hope this was an interesting and useful commentary for everyone. If the positive feedback I get is any indication, then I'm on the right track, and busting my hump to produce these long commentaries is well worth it. I don't mind doing the work, as long as it is helping people out on their journey towards their trading goals. Everyone has to find their own way, craft their own methodology that suits them.
I try to show some of what I've learned, what I've developed, in hopes that it not only offers up some techniques to study, but provides some inspiration as to what can be done when one works tirelessly at one's craft. I hope that some day I hear back from at least a few people and they tell me how they really turned a corner in their studies upon being inspired to work much harder after reading my commentaries. Now, that would inspire me!
The next commentary will be next month's edition, posted by Sunday evening, August 1, 2010.
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