Analysis, Perspective, Trading Strategy
It’s a Market for the Patient, not the Fittest
By Joe Duarte on March 31, 2019
stock market remains in an uptrend and if there is a surprise to come
it may well be a positive one. Yet, even as the technical signs point
to higher prices, the daily headlines and the presence of high frequency
trading algos (HFT) will likely continue to exert their influence on
prices leading to choppy intraday trading on a frequent basis.
I’m neither for nor against HFT. Clearly it’s a fact of life and
it’s not going away. Moreover since I trade daily, I just deal with
it. Nevertheless, in order to plan accordingly and adjust to the reality
of the moment, it’s important for individual investors to understand
how the presence of HFT in the markets affects their money.
Last week, in this space, I described in detail how the HFT algos
make money by purchasing preferred access to the markets from the stock
exchanges, by having faster connections to the trading floors and by
being in place waiting for slow trades to arrive and trading ahead
of them. And although this sounds nefarious, it is perfectly legal
and does have a backhanded positive effect on the markets, which is
that it accentuates the market’s trend and indirectly confirms the
best way to trade, short or long, as you follow the algos.
In other words, when you watch the market’s action in these days
of HFT, there is no doubt as to the prevailing trend at any given time,
with a few small twists. This is because by virtue of their preferred
access and faster Internet connections to the trading floors, the algos
know every trader’s intentions before the exchange can execute the
trade. Thus, they can act upon it before the slower trade gets to the
exchange. This creates a situation in which the majority of trades
trend similarly and, in a perverse way, reflect the intentions of the
trading majority. Thus, the trend, for lack of a better word, is true,
until it’s not. What that means is that up is usually up and down is
usually down until the prevailing number of trades that are coming
into the exchanges change course and the algos follow the new trend.
Another way to look at it is that when we have three to four good
solid days of the market rising, it’s a realistic picture of the trend
during that time. But when the buying dries up and the sellers come
back, the down trend is then accentuated as the algos go with the flow
since they know the flow before anyone else does.
So in this herky-jerky market, what we’re seeing is a lot of short
term bursts of buying and selling and occasionally some large intraday
price swings but no breakout or breakdown in the market indexes. This
is because any stock that sees any heavy volume, even for a short period
of time is vulnerable to the actions of the algos as they accentuate
the action at that moment. The quick reversals come when the original
buyer or seller is done with his buying or selling and the algos jump
to the other side of the trade. This goes on and on all daylong and
increases the intraday volatility which causes the market spasms and
the frequent price gaps which seem to happen more often of late.
What this means is that any portfolio that is up at the start of
the day could be well off by mid-day only to return to even as the
day ends, unless the intraday volatility triggered any individual sell
stops and the portfolio manager was forced to trade. Therefore patience
is clearly a virtue in order to stay afloat in this market.
- Calendar : The U.S. Employment report is due
at the end of the week. Meanwhile keep an eye on the U.S. ISM manufacturing
data and retail sales.
- Big Picture : The third year of the Presidential
Cycle (2019) is traditionally bullish for stocks. The political winds
may have changed somewhat after the release of the Mueller report
summary. Keep a very close eye on U.S. China trade talks.
- Risk : Headline risk remains.
- Market Behavior : The trend is turning up. Volatility
won’t go away. Algos are buying on dips. A sustained reversal of
this trading pattern would be very negative moving forward.
- What to do : Stay patient. Expect volatility.
Hedge when it’s called for but not excessively. Manage positions
individually. Give stocks more room to maneuver by widening sell
stops but sell if your stops get hit. Use options for high priced
Market Breadth Remains Positive – Index Technicals Improve
The New York Stock Exchange Advance Decline line remains in a positive
trend, which is a big plus for this market, given this indicator’s
record of predicting the overall market’s trend since the 2016 presidential
The S & P 500 (SPX) remains range bound with 2700 and the 200
day moving average providing a floor of support for now while 2900
remains an upside resistance barrier.
However, a most encouraging sign is the improvement
in the Accumulation-Distribution (ADI) and On Balance Volume (OBV)
indicators for SPX, which is a sign that money is coming back into
stocks. Even better is the fact that the RSI has worked off its overbought
state without a major market crash.
Meanwhile, the Nasdaq 100 Index (NDX) has support
with 7200 and the 200 day moving average while 7500-7700 is overhead
resistance. Here also the improving ADI and OBV mirror those seen in
Patience is Indeed a Virtue
Investors who can withstand the HFT induced intraday volatility in
the stock market and remain patient are likely to be rewarded if the
technical signs that suggest a move to the upside is brewing are correct.
Of course, there are no guarantees, especially in a headline driven
market. However, if there are no nasty surprises from the Federal Reserve
and other external sources and the economy shows signs of improvement,
I expect a nice move up in stocks over the next few weeks.
That said, as long as the 20, 50, and 200-day moving averages for
SPX and NDX remain reliable support levels, the trend remains to the
Joe Duarte has been an active trader and widely recognized stock
market analyst since 1987. He is author of Trading
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