What Is a Coiled Market?
A coiled market, or coiled spring, is a market that has a lot of potential to make a strong move in one direction after being pushed in the opposite direction or held flat over some period of time. The idea is that if a market ought to be headed in one direction due to its fundamentals but has experienced pressure in the opposite direction, it will eventually make a strong corrective move in the direction of the core fundamentals.
A coiled spring move will often be more substantial than what might have been otherwise if the market had continued incrementally in the fundamentals-driven direction without interference.
- A coiled market is one where traders anticipate a strong reversal in the near future in order to align with fundamentals.
- Like a coiled spring waiting to pop, a market that has been trending away from core fundamentals due to various short-term pressures may also pop in the other direction.
- Coiled markets are most often observed in commodities and forex markets where hedgers or government policy may create temporary distortions in prices.
Understanding Coiled Markets
Coiled markets happen when the market has been held artificially held down. Commonly, a coiled market snap-back will occur in the commodities markets, such as gold and silver, but can befall any market.
Technical analysts look to triangle patterns on charts to spot potential coils. In this chart pattern, as the upper and lower parts of the triangle move closer towards one another, more price pressure builds up. Like with tectonic plates in the earth, eventually the built-up pressure will look for a release. As pent-up energy increases, theoretically, the more massive the breakout will be.
At some point, prices will move outside of the triangle's boundaries. The question is, whether they will move higher or lower. In the chart below, we see that the market has trended well below the lower bound of the triangle formation, indicating a potentially coiled market.
Example of a Coiled Market
An excellent example of a coiled market is with a government that intervenes in its currency. Market observers often point to China when talking about the potential for a coiled yuan market. The Chinese government has a penchant for placing controls on the yuan, namely keeping it artificially low relative to its fair market value (FMV). If the government were to lift the controls suddenly, the currency would likely increase at a rapid rate.
However, the rebound on a coiled market is not always higher. The market for the British pound sterling (GBP) became coiled in the other direction leading up to September 16, 1992, otherwise known as Black Wednesday. That day, a collapse in the pound sterling forced Britain to withdraw from the European Exchange Rate Mechanism (ERM).
The ERM was introduced in the late 1970s to stabilize European currencies in preparation for the Economic and Monetary Union and the introduction of the euro. Countries seeking to replace their money with the euro were required to keep the value of their currency within a specific range for some years.