Analysis, Perspective, Trading Strategy

Elvis Has Left the Building but We’ve Still got the Bots

By Joe Duarte on August 5, 2018

Who needs Elvis when you’ve got trading bots?

Last week, in this space I noted the stock market had the feel of an Elvis exit from the concert stage where the King had left the building while the band played on and the fans waited for an encore. My point was that since the FAANG stocks hit the skids, it was plausible that the stock market might follow suit and a full blown correction would materialize. Well, that didn’t happen, at least not yet. So unless things change, just as in the King’s heyday fans knew there would always be another opportunity to catch him at another tour stop; it seems the stock market is betting that this bull market still has some life left in it.

Of course, there is no replacing the king. And we all know how that story turned out eventually, although it sure was good while it lasted. Yet in the present market, unlike in the past, trading isn’t about sound trade management and discipline. Instead, stock trading has been reduced to an exercise guided only by the minute by minute analysis of trading headlines by robotic trading algorithms with very short memories and what the programs tell the machines to do based solely on that information. Thus, for those of us who trade for a living, if yet another rally does materialize, it will be time to cross our fingers yet again and hope that this isn’t the bull’s last hurrah. And if it is the last gasp, we can only hope that prudent hedging; small position size and careful risk management is enough to save us from catastrophic losses.

NYAD Traces Bullish Pattern

It’s hard to argue with the New York Stock Exchange Advance Decline line (NYAD) given the fact that it has, like no other indicator, predicted the correct direction of the stock market since the election of Donald Trump. That’s now roughly a 20 month record of being right on the money, which in the annals of the stock market is downright uncanny. So, when I looked at NYAD at the end of the most recent trading week I was happy to see that it is again tracing a bullish consolidation pattern which, if it resolves as it has the other two times it has appeared since November 2016, will likely mean that we are about to get yet another up leg in the market.

More specifically, NYAD has been moving sideways over the last month and accordingly, the Bollinger Bands have been shrinking. Just that latter occurrence suggests that a big move is coming in the not too distant future. However, further scrutiny shows we saw the same pattern, especially the fact that NYAD held above its 20-day moving average at the same time the Bollinger Bands shrunk, on two previous occasions since November 2016 - December 2017 and May 2018. The good news is the market rallied both times after this same consolidation pattern in NYAD broke to the up side.

FAANG Crash Brought Out the Dip Buyers Again

A familiar story played out again, as the late July FAANG stock crash led to yet another episode of what has become a worn out Wall Street acronym: BTFD – Buy-the-Friggin’-Dip. So here we are again with the potential for another up leg in stocks.

The S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes are again sporting signs of accumulation with both the Accumulation Distribution (ADI) and On Balance Volume (OBV) indicators failing to break down last week and hinting that they may actually break out to the upside. If that happens and the market makes a new high I would expect an acceleration of the uptrend, at least for a few more weeks.

There is still low volume on the rallies, though, which suggests that either we are being set up for a nasty reversal since there aren’t enough buyers in the market, or perhaps a lot more trading is going on behind the curtains of the dark pools where only the shadows know what the real best bid is. And although it’s good to consider the why’s of the situation, it really doesn’t matter. For the rest of us, it’s all about the trend anyway. And the trend looks ready to move up again.

Don’t Fight Momentum and Keep your Eye on the Fed

The late Marty Zweig had two golden trading rules:

1) Don’t fight the Fed and

2) Don’t fight market momentum

And while these are sound trading rules which have stood the test of time, it’s hard to reconcile them at this point. For one, the Fed will be raising interest rates for a good while into the future. And for another, the market doesn’t seem to care.

What it all means is that at some point, whenever that is, something will give. And if history is any clue to the future, the Fed will win the battle. Thus, if history holds up, when we reach that point where interest rates hit whatever level spooks the collective market consciousness, prices will tumble. Of course, since the bots don’t care and history is being rewritten as we trade, none of that old stuff may mean anything anymore.

But, if history is still relevant, and I suspect it is, we don’t seem to be there-there yet, at the breaking point. So we trade the long side cautiously with small lots of stocks, options, and hedges while we watch the exits and hope the door doesn’t close on us when the panic starts.

Joe Duarte is an active trader and author of Trading Options for Dummies , now in its third edition and The Everything Investing in your 20s and 30s. To receive Joe’s exclusive stock, option, and ETF recommendations, including trade results, visit www.joeduarteinthemoneyoptions.com.

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