Analysis, Perspective, Trading Strategy
Don’t Trust the Bots: Stay Long but Keep Your Eyes Open
By Joe Duarte on July 8, 2018
In an episode of the Sci-Fi series “Babylon 5”
which ran from 1994-1998 through syndication, and whose basic premise
is not far from today’s Earth and over the top geopolitical situation,
Kosh Naranek, a representative of a secretive alien race, the Vorlons,
once said: “Understanding is a three-edged sword.”
It’s a frightening stock market where little seems to make sense
these days and where understanding is indeed a three-edged sword. Moreover,
it’s a market where as the news gets worse the market rallies to new
highs. Consequently, every new outlandish development raises investors’
fear levels as no one knows what may be around the bend. As a result,
if you trade, it’s hard to shake that nagging feeling in the pit of
your stomach that keeps you on your toes but raises your blood pressure.
And why shouldn’t we all head for the antacids? Everything feels
wrong. It’s no secret that the Fed will continue to raise interest
rates for the foreseeable future and that eventually things will get
very dicey for stocks as investors flee for the safety of higher interest
rate deposits with lower risk than stocks. Geopolitical risk is high
and rising with frequent and conflicting reports making facts difficult
to process and often leaving investors with only the “better” of two
bad choices as actionable alternatives. Furthermore, volatility is
on the rise with 100 point price swings in the Dow Jones Industrial
average occurring on a daily basis and sometimes on an hourly basis
given the headlines of the day.
Of course, this volatility is due to the prevalence of robotic trading
algorithms whose programs are designed to move money in and out of
the stock market based on headlines and technical indicators such as
support and resistance levels. What is also clear is that robot algorithms
have clearly been programmed with strong digital stomachs along with
heeding the words of J.P. Morgan: “Buy when there is blood in the streets.”
Certainly we can complain and wish things were as they once might have
been, but it’s not worth the trouble. Successful trading, at least
for now calls for a new approach. Since robots rule the market, it’s
important to understand how they “think” and to adjust to the reality
of the trading moment.
As Martin Zweig famously said; “don’t fight the market’s momentum.”
The Trend Remains Bullish
Taken at face value we are in a scary place. Nearly a decade into
what is clearly a secular bull market in stocks and nearly nineteen
months into the rally that started in November 2016 after the election
of Donald Trump, the New York Stock Exchange Advance Decline line (NYAD)
has made yet another new high. Now while some may wonder as to what
this could mean, I will again point out that the NYAD has been the
most accurate indicator of the market’s trend since the November 2016
election. Furthermore, what that means to me, is that until NYAD is
proven to be wrong, I will follow its lead and stay long stocks, albeit
with one eye on the exit and one foot in the door.
As I noted last week, the NYAD had touched its lower Bollinger Band
at the end of June, the eleventh time it had done so since November
2016. And as it had done eight previous times, this tag led to yet
another reversal of the line to the up side. Furthermore, the upward
thrust in NYAD was much stronger this time than in recent times during
the post election rally, which suggests that before the market pulls
back at some point, we may see some very dramatic gains.
Don’t Sweat the Lagging Indexes for Now
While NYAD has broken out to the upside, the Nasdaq 100 (NDX) and
the S & P 500 (SPX) indexes have yet to deliver a new high. This
is not necessarily bearish, especially if the indexes remain in trading
ranges and NYAD keeps climbing.
Moreover, the fact that NYAD keeps climbing says that more stocks
are participating in the rally than those that are falling in price.
And when more stocks participate in any rally it raises the odds of
individual stock pickers picking winners and making money. Thus, as
long as NYAD keeps moving higher, the odds of making money favor active
investors who can pick stocks with above average odds of moving up
That said, there are still some
points worth considering.
1) Volume remains a problem for the indexes
2) NDX and technology stocks are starting to lag
3) ROC, which measures momentum, remains below the zero line for
both NDX and SPX
These indicators suggest that even though the trend remains up, volatility
is likely to continue and that the market remains vulnerable to headlines.
Don’t Trust the Bots: Stay Long but Keep Your Eyes Open
Don’t trust the robots. But don’t ignore their influence on the markets
and how you can use what you know about them to make money. Indeed,
2018 may go down in the books as a year in which cautious stock pickers
whose focus remains on balancing profits and risk management beat the
indexes. Therefore, the major focal points remain the same. Trade in
small lots. Look outside the indexes for stocks with sound fundamentals
and strong technicals. Consider using inverse ETFs as a portfolio hedge.
Use options and option strategies such as Buy-Write and spreads to
diversify holdings and decrease downside risk.
This is what’s working right now. Tomorrow may be a different day.
“Understanding is (indeed) a three edged sword.”
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