Fed Chair Yellen, in this week’s testimony to Congress, highlighted the long-term context of the short-term drop in the markets in early 2016 as well as medium-term challenges like the slowdown in China and the slump in crude oil. Similarly, short-term traders should trade with an awareness of the longer-term context.
By Vikram Rangala
Thursday, February 11, 2016
“Financial conditions in the US have recently become less supportive of growth,” is how Chair Yellen, head of the Federal Reserve, summarized her view to Congress yesterday in testimony before the House Financial Services Committee. She cited several specific factors hurting economic growth in recent months.
Yellen first pointed to the most obvious, the drop in global stock prices, which is big enough to have people switching from “correction” to “bear market” in their attempts to describe what’s happening. She also cited the rise in interest rates, particularly for riskier borrowers and a strengthening dollar.
Lending rates are an issue because when banks are so risk-averse they won’t offer affordable loans to entrepreneurs or offer mortgages to anyone but the well-financed, growth suffers. The engine of economic growth is trust, also known as credit. Risky borrowers are an asset, not a liability, as long as that risk is reasonable.
The strong dollar is a challenge for several reasons, most directly because it has hurt US export sales and profits. How badly does it hurt them? Last quarter, General Motors reported 100% of its profits came from North American sales. GM manufactures autos in 37 countries around the world and sells its products in over 120 countries. If zero percent of its profits came from those 34 other countries it shows how off balance things are.
Stocks, interest rates, and the dollar are all things that the Fed is watching. Thing is, they are also things the Fed has influence over, to some degree. Yellen also cited outside factors, which are long-term in nature and over which the Fed has little or no direct control.
Slowed economic growth in China and its exchange-rate policy, she told representatives, ““exacerbated concerns about the outlook for global growth.” However, she also said that the drop in the prices of commodities, particularly crude oil, was partly a result of China’s weakness. She drew a connection from China to commodities and back to the US economy, saying developments in China can “pose risks to US economic growth.”
Yellen’s acknowledgement that the Fed has to make policy with the awareness of market forces it cannot control is a lesson for investors and traders. There are larger forces even the Fed has to adapt to and work with, not try to control or fight. In the same way, investors and traders have to consider the bigger context in which they take their positions.
Let’s say, for example, that you’re a swing trader who buys stock index futures hoping to capitalize on a bounce. Simply jumping on three successive bars of higher highs and higher lows, or buying a slight uptick from a support level, is a risky move to make. To make that risk pay off, you have to be aware that there is a long-term downtrend and you are trying to trade a short-term reversal within it.
You have to time your entry so that you catch the reversal move early and get out before the downtrend resumes. Being too late or overstaying your welcome are a sure way to lose money even while being right about the direction of the move. So is buying too soon and getting stopped out because the downtrend continued instead of reversing when you thought it would.
Here at Nadex, we offer binary options and spreads that can make it less punishing to be a little bit off in your entry timing and allow you to stay in the trade without getting stopped out. On Nadex, you never get stopped out. If you reach the maximum predefined loss, you stop losing money but you remain in the trade. That doesn’t make Nadex easier—it’s still challenging, real trading—but it does let you decide your risk before you enter, so you can focus on the trade itself as it progresses.
Whether you’re on Nadex or another exchange, trading binary options or futures or stocks, one strategy is always helpful as you trade short and medium timeframes: keep an eye on the bigger, long-term movements and the ones making those moves happen. Smaller fish keep an eye out for the big fish while they hunt. China is a big fish, which is why the Federal Reserve has become a keen China watcher.
One more example: a lot of oil traders and analysts are speculating that oil is going back up to $50 a barrel by fall. Whether you agree and want to buy, or you disagree and want to, for example, sell calls or binary options, you should keep an eye on the growth of solar and wind and the upcoming $35,000 electric car. That’s the long-term trend for crude oil: the end of the fossil fuel era. Nothing lasts forever except change. Traders and investors who remember that can profit no matter what the Fed does.
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