by Chris Becker
A bull trap seems more than possible in iron ore stocks with several catalysts providing the torque for shorts to cover and the foolish to rush in.
Let’s have a look at them:
- iron ore prices rallied yesterday – spot up $1
- the Fed said everything was fine this morning
- the ASX200 looks set to go up at least 20 points or 0.5% on the open
- BHP and RIO were up over 1% in London trade
Some junior iron ore miners rallied yesterday – Atlas Iron (AGO) up 7%, Mt Gibson Iron (MGX) up nearly 4% and perennial favourite Fortescue (FMG) up 2% – and look set to continue today given all of the above.
But is it wise to join the clutching straws crowd here? The phrase “catching a falling knife” is cute, but overused, as there is more nuance to price action. Prices will regularly swing way out of proportion (oversold/overbought) and oscillate around their structural trends, but bottoms in downtrends are always started by an inevitable bounce, usually off a prior support level.
If this is a structural bottom, you won’t know until weeks or months ahead. If you define your risk now, have a set “cry uncle” point where you’ll get out and take a small bite, you are further ahead than anyone who just says “buy now its cheap” confusing this as a cyclical move within a structural downtrend.
The problem is there is little or no support below for most of the iron ore players:
Having put your fire out, I must mention that there is always opportunities on the long side. Instead of a bull trap there is a smaller chance of a bear trap.
There is no certainty that iron ore will not rally back up to $100 or even $120, and on such a move, the juniors could rally 20,30 or even 50% or higher as they did from July to December last year. And Fortescue (FMG), the most volatile of iron ore plays, could move up to recent resistance/downtrend line at $4.25 to $4.40 in a heartbeat:
You can have an opinion about price levels and directions, but don’t let opportunities go by just because they go against your opinion. Investing is all about taking risks and the biggest risk with the lowest payoff is having a stubborn opinion and not taking advantage of an opportunity falling at your feet.
But do not confuse bottom picking with investment acumen. Instead, rely on prudent risk management going long or short, and allow the price to tell you what is going on.