Scaling Fear & Greed

Markets are dead, waiting for the big news catalyst that would start a chain reaction. As a trader, we have to know that there is no way to predict the side it would break. It has a 50-50 chance to go up or down. So whenever somebody (even) tells you that he expected a break to the upside or to the downside, it’s just a matter of luck you have a 50% chance to be right. So, only until it hits the range resistance or range support that price action (and only live price action – not technical or fundamental analysis) can give you a clue on if it will break or not. So, right now, until some news hit the wires, range traders are cashing out big time.

The range in EUR/USD is getting narrower by the hour which would suggest the break would be bigger. We’ve been stuck in a 200-pip-range since last Thursday and now we’re in a 100-pip-range. Only Gold is following its upward trend making big gains yesterday. Which make us ask the question why? Here’s the answer:

We all know that markets are determined by the risk-taking and risk-aversion state of mind of traders. In other words, it’s a risk-off / risk-on switch, whenever traders are optimistic about the general economy, their greed grow making the higher yielding pairs or currencies go up. The opposite happens whenever traders are pessimistic regarding the economy and the “safe” currencies would benefit from the fear of these investors (mainly the USD and Gold). That is quite simple action-reaction we’ve learned and understood a long time ago. But! There this process is not a “switch” (like I described earlier) that only has 2 options; risk-on and risk-off. There’s a certain scale to how much greed or fear are dominating the markets. I will expose below 2 more options:

1-Greed is at its optimum: Traders and investors are very confident with the underlying economy; they see the world prospering in the next few months or better say, in the next few years. Their favorite investment tools would be those that yield the most. They will go and try to find some foreign bonds in emerging countries where they benefit from very high yields. They will also switch from buying bonds to buying stocks in developed countries. Bond traders will be criticized because they’ll be making the less money.

2-Greed is there, but it’s not at its optimum: Investors will go for instruments that yield high, but at the same time it yields a lot lower than emerging markets. The preferred financial tools selected would be those that have a sound yield/risk ratio. Of course, it depends on how each investor evaluates the risk, but in Forex, these tools would be those who have a higher interest rate like the Euro, the pound and the Canadian dollar etc… Of course, you can add to that the stocks of developed countries.

3-Fear is dominating but limited: This is the scenario that played out yesterday. When fear is dominating the markets but this same fear is limited; investors will move from high yielding instruments to Gold (and sometime other safe commodities like silver). Gold has proven itself as the most secure “currency” you can hold. That’s not all! With Gold rising every day and expected to hit new record highs, it constitutes the metal where traders invest in blindly whenever they have doubt about the future of global economics. Furthermore, investors will switch from stocks to bonds, here’s where the bond traders take their revenge.

4-Fear is king: When panic hits the markets (a good example would be what happened in 2008) and when fear that for a reason or another, cash money may be in risk of not being available for most of us; it’s not the time to invest. Instead, investors will liquidate their positions to get cash in their pockets. And what would be the preferred currency?.... Yes! Absolutely… the USD.

Of course, there are a lot of market conditions that would dictate other scenarios. But fully understanding these four scenarios is enough to have a clear sight of what is happening behind your charts.