How to navigate the current tariff driven chaos in the market
The following headline got me thinking of a way to put the recent price action, led by a meltdown in U.S. stocks, in perspective.
Hedge funds unwinding risk as in early days of COVID,
What I came up with is to divide it into three phases
Phase 1: Liquidating market
Phase 2: Consolidation
Phase 3: Make or break
Phase 1: Liquidating market
This is a term I have used in the path to describe a market that is driven by liquidating positions. A liquidating market is one where the flows are looking to exit positions and not add to existing ones.
For example, take US equities, which had built up significant long positions in anticipation of a business friendly Trump administration enacting policies to boost the economy.
Instead, it has been weeks of market chaos and uncertainty, fueled by erratic on again, off again, back on again tariff pronouncements and risk of retaliation. In addition, the DOGE chainsaw approach to reducing the size of government has undermined confidence and raised talk of a recession risk. It is no wonder markets have been forced to scale back risk.
As this weekly US50O chart shows, it appears to have been a one-way street down. However, those trading in the trenches know it has been more a series of fits and starts, which is typical of a liquidating market.
What happens in this phase (and in Phase 2) is attemptS to correct tend to be short-lived. Once weak positions get shaken out, even in a modest correction, a market is left less net short (long). The result Is then a run the low (high) as a market is less able to absorb fresh selling (buying).
Phase 2: Consolidation
This brings us to Phase 2, which is the period after liquidations have run their course and markets try to take a pause.
As can be seen by this chart, Phase 2 is often characterized by attempts to correct as the selling (buying) liquidation phase slows . As this chart shows,, the failure to follow through on the correction sets up a run at a new low but not with the power seen in Phase 1. In this phase only breaks of the lows (highs) would trigger stops and force more selling (buying).
Unlike Phase 1 where liquidations drive the price action, it would take fresh selling (buying) to extend the moves
This was a classic example of a failed correction saetting up a break to a new low.
Phase 3: Make or Break
Phase 3 is called make or break. What that means is make new lows (highs) or the risk shifts to a break of momentum..
Phase 3 is a tricky time as there are those betting on new lows (highs) while others are looking for a bottom (top).
This tends to be a phase driven more by speculative trading with the bulk of the real money flows taking place in Phase 1 and to a lesser extent in Phase 2.
In Phase 3, a clue can be found in how markets react to news, especially headlines that triggered the liquidations in Phase 1
In any case, as a trader, you don’t want to be trading an old trading episode when a new one has begun, Key here are the latest lows (highs) as that is the where there would be stops and as most should be aware by now, markets, especially FOREX, are in a constant quest to run them.
When there are no moire stops left to run, markets will tend to lose interest on that side and either go sideways or look to probe the other way in a search of stops.
What Phase are we currently in?
Markets would like to be in Phase 3, which is the make or break time but are probably in Phase 2 until the tariff soap opera and its implications become clearer. It is premature to consider Phase 3.
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