Analysis, Perspective, Trading Strategy
At the Edge of Chaos: Don’t Fight the Fed but be Cautious and Consider Options for Risk Management
Editor Joe
Duarte in the Money Options
The
stock market’s uptrend seems to be hanging on by a thread, yet the
Federal Reserve has made it clear that it will continue to pump liquidity
into the banking system, to the tune of at least $120 billion per month,
a $40 billion increase from its recent easing, while keeping interest
rates near zero until 2023. Moreover, despite the recent selling, history
shows that under normal circumstances, this type of central bank action
should be creating a virtuous cycle where a rising stock market, which
is now leading the economy as the number one influence in the complex
system composed of the markets (M), the economy (E) and people’s lives
and financial decisions (L) should be moving higher.
In other words, unless this time is really different the current
stock market selloff should pass and the uptrend should resume. On
the other hand, if the current relationship reverses and market decline
continues, then the economy will likely slow and the virtuous cycle
could reverse and turn into a vicious cycle. Nevertheless, there is
no substitute for being ready for any contingency, as I discuss directly
below.
Is $120 Billion per Month Enough for the Algos?
Last week in this space, I noted: “Investors are caught in the middle
of three major influences: the election, the Fed, and the algos,” while
further noting “so the big question is whether the Fed is pumping enough
cash into the system to keep the stock market from breaking below key
support or whether they have to resort to yet another nuclear money
blast.”
Indeed, the Fed decided to deploy at least a mini bazooka last week
by increasing its monthly market operations by one third, an amount
that was good enough to kick the high frequency (HFT) computer trading
programs into a more aggressive buy mode for about an hour before the
selling resumed. Thus it’s clear that for now, the algos seem to want
more from the Fed, so here are three things to consider if things don’t
change:
- As the election season heats up the polls become tighter, and
the inter-party rhetoric becomes more explosive – especially regarding
the Supreme Court - expect more volatility
- The Fed’s increased bond purchases are likely bullish for the
industrial sector but perhaps not for the entire market
- The HFT algos will do two things: front run the money flow, up
or down, and accelerate the prevailing trend
What it all adds up to, is that until proven otherwise, the likelihood
of an uneven market are on the rise until we get some real election
clarity, which may or may not come before the end of the year. Of course,
the entire scenario may change due to other external developments,
especially in the geopolitical arena, such as if the polls suddenly
reveal that one side or the other is finally gaining the upper hand
decisively.
For more details on how to pick winning stocks in any market, visit
my September 16, 2020 Virtual Money Show presentation by clicking here.
Trading Principles Remain Key to Success in this Market
As the bull market ages and the election nears, it’s reasonable to
expect market volatility despite the Fed’s increase in its money infusion
into the bond market and the financial system via its bond and ETF
purchases. As a result, it’s important to review our sound trading
principles:
- Don’t fight the Fed
- Don’t fight the market’s dominant trend and momentum
- Stick with strong stocks in strong sectors
- Take profits on 20% winners
- Use 5-8% sell stops
- To minimize portfolio volatility, trade in small to moderate share
lots
- Monitor down sectors for possible turn around stocks to consider
- Use sound money management principles
- It’s now a good time to start looking at options as risk management
tools
Big Momentum Surge May be in Store for Extra Space Storage
Shares of the #2 self storage company in the U.S., Extra Space Storage
(EXR) have been steadily rising over the last few weeks but are now
reaching a price point, near $112 where momentum investors may start
to add to positions aggressively if the stock can survive the current
general market pullback. Moreover, if the stock holds up in the next
few days, the current mild downdraft may be a good opportunity to buy
on the dip.

The company has certainly benefited from circumstances over the last
few months and has recovered well from the initial COVID-19 market
wide decline. Specifically, the migration dynamic from large cities
has been quite beneficial as limited capacity from movers has led to
a rise in demand for storage. In fact, as people wait for their new
homes to be built or vacated in the suburbs or even in new cities,
the demand for storage in new destinations is also growing. Of course,
there is the potential for trouble in collecting rent for spaces if
the economy slows, but for now buyers are in control and momentum is
rising.
Especially bullish are the rise in Accumulation/Distribution (ADI) and
On Balance Volume (OBV) along with a small Volume by Price (VBP) bar
near $112. In fact, the key is the VBP, which is providing a last point
of price resistance. If the stock can clear this barrier, the likelihood
of a buying surge will increase as momentum investors, and HFT algos
will likely pile into the stock. At this point, if the stock can clear
this final shelf of resistance, it could well move into the $120 area
fairly quickly, barring any major external market wide problems.
NYAD Ends Yet another Week on the Brink of Sell Signal
The New York Stock Exchange Advance Decline line (NYAD) closed the
week at its 50-day moving average while the RSI for the indicator closed
below 50 giving us yet another near but not fully developed Duarte
50-50 Sell Signal.

As I’ve noted here previously, if this becomes a full blown sell
signal it would be the fourth signal since the election of 2016, with
previous signals noted in the bullets below:
- February 2018
- October 2019
- February 2020
Moreover, since each of the three sell signals led to a dramatic
selling spree, and since each succeeding signal preceded a more violent
selling spree than the previous one, and with the market having a lot
to think about these days we could see a huge decline, perhaps even
in a short period of time. Specifically, the most recent was in March
of 2020 when the S & P 500 (SPX) was down 30% in six weeks.

For their part, the S & P 500 (SPX) and the Nasdaq 100 (NDX)
indices are both showing fairly weak trading patterns of late with
the latter being the worse of the two as aggressive sellers have been
pummeling the technology sector.

n fact, both SPX and NDX have already delivered their own version
of the 50-50 sell signal, which should raise concern among investors,
unless these events are not reversed.
For a full in detail tutorial on how to use the NYSE Advance Decline
line to figure out the market’s dominant trend check out my latest
Your Daily Five video here.
Don’t Fight the Fed but Be Selective and Consider Options
With stock market valuations near record highs and a bumpy election
taking shape, it seems counterintuitive to wish to buy stocks. But
in some cases that’s the current situation faced by investors. And
to be frank, given the potential for rapid market swings, the current
market is not for everyone.
Nevertheless, active investors should continue to cautiously trade
the dominant trend which until it is clearly reversed remains to the
upside as the Federal Reserve’s easy money works its way into the stock
market moving stocks higher. Of course, given the fact that a fool
and his money are soon parted, it is imperative to follow sound trading
principles including sticking to strong stocks in strong sectors, to
deploy well applied sell stops, and to stay disciplined by taking profits
where appropriate, while also trading in small to moderate lots in
order to prevent portfolio volatility.
Finally, as stock prices have come down, the spread in the options
market have improved and due to increasing participation by individual
investors liquidity seems to have improved a bit. What that means is
that it’s a good time to use options once again as risk management
and income vehicles.
I just posted a new options trade that you can view when you sign
up for a Free Trial of Joe Duarte in the Money Options.com. Click here.
To learn more about options check out my February 2020 Money Show interview here.
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.
Meanwhile, the U.S. Ten Year note yield (TNX) is trading in a The
Everything Investing in your 20s & 30s at Amazon and The
Everything Investing in your 20s & 30s at Barnes and Noble.
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