-- Trading at the Edge of Chaos --

Analysis, Perspective, Trading Strategy

At the Edge of Chaos: Liquidity Pushes MEL toward Post New Normal Emergence

Editor Joe Duarte in the Money Options

I am trading this rally on the long side for two reasons: it is folly to fight the Fed and it is equally foolish to fight the market’s momentum until proven otherwise.

Moreover, and I say with some trepidation, we may be reaching a point where the balance between the components of MEL, the complex adaptive system comprised of the stock market (M), the economy, (E) and people’s lives (L) is nearing a point of emergence to a new level of operation. Foremost, if this is correct, then because of the way algos are programmed, the Fed’s actions are paramount.

In other words, as long as the Fed is easing, the odds favor higher stock prices. So until proven otherwise be prepared for the emerging new reality of the Post New Normal World.

Trading is Still Dangerous but Difficult to Avoid

Trading stocks remains dangerous. Still as traders, the only viable strategy is to trade with the trend, as long as the trend is reliable. Certainly things could change quickly; as I’ve been saying for weeks as early as the Sunday night futures open, especially after a session where the action may have easily been influenced by options expiring such as what we saw on April 17.

Still, boosted by easy money from central banks the stock market continues to defy the grim fundamentals of the global economy supporting the notion that for now liquidity is winning the battle and that perhaps, as I discuss below we are witnessing a major change in MEL.

Accordingly there are some interesting developments worth noting:

  • Trading patterns in many individual stocks, are starting to return to some semblance of normalcy
  • Trading patterns in the major indexes remain volatile and continue to feature wild point swings
  • As earnings season develops the focus is likely to be on the fortunes of individual companies
  • Trading success will now hinge more on stock picking and risk management instead of just buying oversold stocks

MEL is on the Move

There are important positives and negatives unfolding in MEL, the complex adaptive system composed of the Markets (M), the Economy (E) and people’s lives (L). While stocks have rebounded, we have rising joblessness, stalling commerce, an increasingly dangerous geopolitical tone and a new set of rules for human interaction: social distancing, video conferencing, and the possibility that face masks will become a long term fashion accessory around the world.

Yet, even as protests appear in U.S. state capitals we also see evidence of Complexity, the process through which orderly change occurs in the Universe slowly curtailing the activity of its disorderly cousin Chaos. Note that key agents in the system, people, governments, and companies are also adapting to the new reality of living in a world of unknown infection risk by working at home, adapting their businesses to the new rules and by looking for ways to survive and someday again thrive. Moreover, just as some people and some businesses are doing better than others this process of adaptation is visible in the stock market where some stocks are also acting better than others.

Moving toward the Edge of Chaos

What we are witnessing is a classic display of a complex adaptive system moving toward a point of emergence; where the optimal level of operation known as the Edge of Chaos (EOC) - the transition point between Chaos and Complexity exerts its maximum influence. Emergence is crucial to the existence of the system as it is followed by Coevolution, the process through which different systems simultaneously adapt to the new reality. What this means, if the current trends remain in motion is that in the not too distant future we may all have to recalibrate how we look at the world, how we trade, and how we live.

Moreover, where in life EOC is about finding solutions to coronavirus problems, in a stock or index chart, it is marked by the price action along key support and resistance areas, such as the 20, 50, and 200 day moving averages. Of these three key dividers, the 200-day is the most important as it is a long term dividing line between bear markets (Chaos) and bull markets (Complexity), whereas the 20 and 50 day moving averages are important dividing lines between short (20 day) and intermediate (50 day) term up and down trends. Interestingly, as I point out below, credible trading action is now taking place above the 20, 50 and 200 day moving averages, which is clearly a positive for the stock markets (M). Now, we have to see how the economy (E) and people’s lives (L) respond.

Markets May Replace Economy as Leading Edge in MEL

Indeed, my current analysis suggests that the markets are on the verge of becoming the leading component of MEL. This is due to the fact that 401 (k) plans are central to the wealth effect for many people. Thus, the stock market’s rally has been a psychological positive of sorts to those who may be temporarily out of work or are working part time.

Therefore if the rally does not fall apart, and it is followed at some point in the not too distant future by a reasonably credible improvement in the economy, no matter how small, it could mean that MEL has emerged to a new operating level where the action in the stock market will be the crucial factor influencing economic activity via its positive effect on the 401 (k) plan, fully reversing the traditional relationship where economic activity is seen as fueling the market’s price action.

Heady theories aside, the coronavirus is a purely chaotic entity, as are all diseases. That means that its actions are predictably unpredictable. Therefore, any type of action plan for a return to normal may still face significant setbacks at any time as Chaos tries to reassert itself as the dominant macro influence in the world. What that means is that investors should have a balanced approach to trading at this point.

Translating this to action means that owning stocks is still a day to day, perhaps a week to week exercise until proven otherwise. Moreover, trading small lots, keeping higher than normal cash levels, and taking profits as they appear while using well placed sell stops is still the best way to trade in this market.

Akamai: From the Shadows to the Sunlight in a Cloud World

Shares of Akamai Technologies (AKAM), a leading provider of cloud infrastructure and services delivered a credible price breakout last week as the coronavirus situation continues to increase demand for its business. Perhaps the most interesting aspect of this stock, which I recommended to premium subscribers of Joe Duarte in the Money Options.com before the breakout, is that it is not a very well known company.

 

 

But even so, its story is fairly compelling at the moment, and the stock has the potential to climb higher over the next few months barring an all out return of the bear market. Consider the fact that there are still major cities such as New York, London, and Los Angeles which are still on lockdown, with significant questions remaining about the reopening of the global economy.

Moreover, it is now plausible to consider that the explosive growth of telemedicine and teleconferencing are here to stay for the foreseeable future. What that means is that companies like Akamai who provide the server space, software, and security framework for telework and content streaming may just be getting started in what could be a multi-quarter and perhaps longer earnings growth cycle.

Certainly, Akamai’s breakout and recent brokerage upgrades suggest that there is interest in the shares. Moreover, the stock is still far from being a household name, which means that what was once an obscure, certainly well run cloud company is about to be thrust into the limelight, and that could mean an even larger following. Right now the shares look attractive as long as they hold above the $98 support area. Earnings are due at the end of April, so it will be interesting to see what happens between now and then, and of course, how the market responds to the company’s earnings report. For more details about Akamai and other stocks that which should profit from key changes in MEL, check out a FREE trial to Joe Duarte in the Money Options.com.

NYAD Holds above 200 Day Moving Average

The good news is that the New York Stock Exchange Advance Decline line (NYAD) remained above its 200day moving average for two consecutive Fridays. The neutral news is that it did not cross above its 50 day line, which means that we are still operating under a partial all clear.

 

 

That said, the Nasdaq 100 index (NDX) is trading well above its 50 and 200 day moving averages with positive On Balance Volume (OBV) and Accumulation Distribution (ADI) confirming a return to a positive trend. NDX does have some overhead resistance near the 9000 area which is likely to lead to a pause in the uptrend at some point in the not too distant future.

 

 

The S& P 500 (SPX) is slightly behind but also closed above its 50 but not above its 200 day moving average. Still, and this is an important point, the RSI indicator for NYAD, SPX, and NDX is still hugging the 50 area, which means the market is not yet overbought, and could still move higher.

 

 

The bottom line is that some parts of the stock market are doing better than others but that we are seeing a fairly well spread out recovery with technology leading the way higher.

Trade Individual Stocks not the Whole Market

We are caught in a war between Chaos and Complexity as we near the point of emergence and a potential Post New Normal world. And while we can’t control the forces of the Universe, we can certainly control our trading.

What that means is that we trade small lots and we keep short term time frames; trading day to day. If a stock is not working, we should consider cutting our losses short. If we have profits we should consider paring down the position by fading big rallies. And if the market turns against us, we should trade each position individually, meaning if it’s working we hang on to it with well placed stops while we sell laggards.

Finally, keep higher levels of cash than usual in order to survive any unforeseen attacks from Chaos.

I own shares in AKAM as of this writing.

Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best sellingTrading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com - now in its third edition, The Everything Investing in your 20s and 30s and six other trading books.

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