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Tuesday April 25, 2006 - 10:51:45 GMT
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Why prices seem to fall faster...

Quotable

“I made my money by selling too soon.”

Benard Baruch

FX Trading – A brief look at why prices seem to fall faster than they rise

Ah…the ubiquitous “profit taking.” It seems a financial journalists’ fall back position whenever there is no other readily available rationale to pin on the price movement. By definition, isn’t profit-taking by one player usually equaled by loss-taking on the part of another?

Are we seeing the type of volatility in the metals which is often a precursor to some type of intermediate-term trend change? Or is ramped-up volatility to become standard fair now that more players have jumped into the game? If so, yesterday’s oil’s slick and silver’s slide is simply symbolic of backing and filling expected after prices move in a parabolic-like manner. We are already seeing crude edging higher and a big bounce in the metals this morning. But, the day is still young.

Day in and day out we use charts to follow the commodities. We apply our technical (bone throwing) wizardry. But about the best we can say is: These markets are “overbought.” Well, isn’t that just a stunning piece of new information? These markets lurch from being overbought to more overbought; then to extremely overbought and yet continue to go higher. In a runaway bull market it’s best to file our bones in the drawer and jump on the trend—that is the message.

Can we see these same extremes in currency markets? You bet we can. Commodities and currencies lend themselves to self-feeding price extremes.

What we are seeing we think can best be described as a boom-bust cycles. In the beginning, and usually much of the way throughout the trend, expectations are based on real reasons which are validated along the way—that builds confidence, and confidence leads to a great commitment in the form of more money being bet on the trend.

It is precisely because this trend takes on a life of its own and draws in greater and greater amounts of capital that makes it dangerous. For at some stage this process is reversed as the key players realize the expectations have grown so far divorced from the underlying fundamentals that a significant price adjustment is required to bring the two back into balance.

“Booms and busts are not symmetrical because, at the inception of a boom, both the volume of credit and the value of collateral are at a minimum; at the time of the bust, both are at a maximum. But there is another factor at play. The liquidation of loans takes time; the faster it has to be accomplished, the greater the effect on the value of collateral. In a bust, the reflexive interaction between loans and collateral becomes compressed within a very short time frame and the consequences can be catastrophic. It is the sudden liquidation of accumulated positions that gives a bust such a different shape from the preceding boom,” writes Mr. George Soros.

In plain English: That’s why markets tend to fall much faster than they rise. Fear is a stronger motivator than greed.


Jack Crooks
Black Swan Capital

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