Monthly Archives: September 2017

Sep 29

Weekly Scorecard: Why this breakout was inevitable

By Jani Ziedins | Scorecard

Welcome to Cracked.Market’s weekly scorecard:

This post includes a summary of the week’s market developments, links to the free posts I published, and analysis on how accurate each post was since I wrote it. 

Weekly Analysis

This week’s theme was “no news is good news”. After several weeks of dire headlines, this week produced very little on the news front. That reprieve from bad news was all this market needed to surge to record highs. As I’ve been saying since early August, a market that refuses to go down will eventually go up. This proved to be the week we’ve been patiently waiting for.

This is a mild breakout as far as breakouts go, but there is nothing wrong with that. The market likes symmetry and last month’s 2% pullback was modest. As a result we should expect an equally modest rebound. This is a healthy market and there is nothing wrong or unusual with these slow and methodical gains.

Few things calm nerves like rising prices. Many of last month’s sellers are quickly going from fear of a crash to fear of being left behind. Underweight money managers are who were waiting for a bigger pullback are starting face the possibility it isn’t going to happen. If this market was vulnerable and fragile, last month’s headlines would have sent us tumbling. Standing strong through both the figurative and two literal storms tells us the path of least resistance remains higher. Gains will continue to be slow and choppy over the near-term, but expect the pace of gains to pick up later in the year as big money starts chasing performance into year-end.

Tuesday September 26th: Why smart traders ignore today’s price-action

In a directional market, a late fizzle like this would be a big red flag. It warns us there is no follow through and support is crumbling. But this isn’t a directional market and traditional trading signals don’t apply.

We have been stuck in a predominantly sideways market most of this year and every breakout and breakdown has been a false alarm. Anyone who failed to realize this has been making the exact wrong trade at the exact wrong moment. Buying the breakout just before it fizzles and selling the breakdown just before it rebounds.

Unfortunately the market fools traders with these tricks far more often than people are willing to admit. That’s because it is nearly impossible to come to the market without a bullish or bearish bias. Many traders cognitively know the market trades sideways 60% of the time, but in the moment they always think prices are either about to take off, or on the verge of collapse.

Score 10/10: In a more typical market, Tuesday’s weak close would have been big red flag and an attractive entry for a short trade. But this isn’t a typical market and we must ignore traditional trading signals. Just as I suspected, Tuesday’s weak close was nothing more than a false alarm and the next four trading sessions saw us charge to record highs.

Thursday September 28th: The bull that refuses to die

Volumes have been average or above since Labor Day. Big money finally returned from vacation and is getting back to work. It is encouraging to see they are more inclined to buy this strength than sell it. Fragile and vulnerable markets tumble quickly. Sticking near the psychologically significant 2,500 level for nearly three-weeks tells us the foundation under our feet is solid.

Earlier in the week we dipped under support, but rather than sell this technical violation, many traders rushed in to buy the dip. Ignore what the bears are saying, this market is healthy and poised to continue higher. August’s basing pattern refreshed the market by chasing off weak owners and replacing them with confident dip buyers. Given how long we have been holding near the highs tells us few owners are taking profits and most are confidently waiting for higher prices. As long as confident owners keep supply tight, expect the drift higher to continue.

Score 10/10: Big money is buying this market, not taking profits. The path of least resistance remains higher and Friday’s surge into record territory confirms it. Without a doubt this market wants to go higher and it is running over anyone who doubts it.

Cracked.Market University:

I started a new educational series and will publish new articles each Monday and Wednesday. Sign up for Free Email Alerts to be notified when new articles are published.

I included a brief quote from each educational piece below. Click on the headline to read the entire article. And don’t forget to come back for next week’s new educational pieces.

The most powerful technique for analyzing the market

Traders often predict the outcome of a market moving event correctly, unfortunately they are not as good at figuring out the market’s reaction. This leads to the popular misconception the market is “fixed” and “rigged”. This couldn’t be further from the truth and I will cover this fallacy in another blog post. In the meantime just take my word for it the market is an equal opportunity humiliator and does a fair and equitable job screwing over both retail and institutional investors. When you lose money, it isn’t because some cunning market villain stole your money, it’s because your analysis is missing key ingredients.

In my two decades of trading, far and away the most effective tool I use in identifying market’s next move is studying what it is NOT doing. Almost everyone obsesses over what the market is doing and tries to to fit these moves into their narratives, whether that is fundamental, technical, or a hybrid of the two.

Why popular investing strategies don’t work

Every popular investing strategy stops working once too many people start using it because the crowd quickly distorts the price-action that made it work in the first place. They sucks up all the profit potential and it is hardly worth the effort. Or the crowd triggers fake breakouts that suck everyone in and then spit them out with less money than they started with.

Knowing what the market is going to do is the easy part. Getting the timing right is where all the money is made. Have insightful analysis like this delivered to your inbox every day during market hours while there is still time to act on it. Sign up for a free two-week trial.

Have a great weekend and I hope to see you again next week.

Jani

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Sep 28

The bull that refuses to die

By Jani Ziedins | End of Day Analysis

End of Day Update:

The S&P500 only closed higher by 0.12%, but that was enough to hit a new record close. Gains have been slow, but steady. There was no meaningful news driving today’s strength, simply a continuation of the recent drift higher. Given how ominous the last several weeks have been, at this point no news is good news. As I’ve been saying for a while, a market that refuses to go down will eventually go up.

It’s been several days since a North Korea headline hit the front page, but even if it did, the market has grown immune to those headlines and it will take something spectacular to dent this rally. Anyone who was afraid of North Korea sold weeks ago. When there is no one left to sell the news, it stops mattering.

The GOP released its tax reform proposal and the market is cautiously optimistic. Given how poorly Republicans handled healthcare, most traders are taking a cynical approach to tax reform. I suspect something will pass eventually, but it will look far different than what was proposed. But at this point anything is a positive since the stock market has largely given up on tax cuts. The easiest way to see the lack of hope is how little the stock market reacted to healthcare’s defeat. The market barely flinched at Trump’s and the Republican’s political humiliation. If traders had high expectations for tax reform, we would have seen a much bigger reaction to the Republican’s inability to get anything accomplished.

Volumes have been average or above since Labor Day. Big money finally returned from vacation and is getting back to work. It is encouraging to see they are more inclined to buy this strength than sell it. Fragile and vulnerable markets tumble quickly. Sticking near the psychologically significant 2,500 level for nearly three-weeks tells us the foundation under our feet is solid.

Earlier in the week we dipped under support, but rather than sell this technical violation, many traders rushed in to buy the dip. Ignore what the bears are saying, this market is healthy and poised to continue higher. August’s basing pattern refreshed the market by chasing off weak owners and replacing them with confident dip buyers. Given how long we have been holding near the highs tells us few owners are taking profits and most are confidently waiting for higher prices. As long as confident owners keep supply tight, expect the drift higher to continue.

August’s 2% pullback was quick and shallow. The market likes symmetry and as a result the subsequent rebound has also been equally unspectacular. There is nothing wrong with that, but it also isn’t a surprise or a concern how slow the breakout has been. Recent sellers are still nervous and it will take a little longer before they conceded selling last month was a mistake and buy back in. But few things calm nerves like rising prices and soon the fear of losses will be replaced by fear of being left behind.

Expect the gains to be slow and choppy over the near term, but soon underweight money managers are going to give up waiting for a larger pullback. Their chasing prices higher will give the market a boost in the final months of 2017. As long as the gains are slow and steady, they will be sustainable. I will get a lot more defensive if the rate of gains ramp up. A good opportunity to take profits could be following a pop on a tax reform agreement.

Expect these daily gyrations to continue, but the path of least resistance remains higher. Stick with what has been working and that is buy-and-hold and adding on dips.

Jani

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Sep 27

CMU: Why popular investing strategies don’t work

By Jani Ziedins | Free CMU

Welcome to the new Cracked.Market University educational series. Look for new articles every Monday and Wednesday.

Why popular investing strategies don’t work

The library, bookstore, and late night TV are filled with “surefire” investing strategies that will allow you to quit your job and live a life of leisure. At least that is what the flashy dust jacket or energetic pitchman promises us. Follow their extra special fundamental screen, chart pattern, or buy a piece of software and you are well on your way to printing money. Sounds great, doesn’t it? If only it was that easy.

The first thing to realize is the stock market is largely a zero-sum game. That means under most circumstances, one trader’s profits come directly out of another trader’s pocket. This isn’t always a bad thing and both of sides can earn handsome profits in a rising market. But like every pyramid scheme, the last person loses out.

Profit opportunities arise in the stock market when prices are not where they are supposed to be. This is commonly referred to as an inefficiency. For one reason or another a stock’s price is out of alignment. Maybe sentiment is overly bullish or bearish. Maybe the public doesn’t know the company’s sales are about to miss expectations by a wide margin. Or maybe a secret product is about to be announced. Whatever the reason, the stock is about to experience a large move and owners are rewarded for being in the right place at the right time.

One of the most important things to realize about these profit opportunities is they are limited in potential. Not everyone can profit from the same opportunity. If too many people buy a discounted stock, their buying increases the stock price until the discount disappears.

Think of these profit opportunities like a $100 bill lying on the street. If I find it by myself, I keep all $100. If a good friend and I see it at the same time, we split it and both of us are $50 richer. If five friends come across the $100, each person benefits by $20. If 1,000 people find the $100, each person gets ten cents and at that point it is hardly worth the effort.

This same phenomena occurs with popular investment strategies. Let’s say a hypothetical formula identifies stocks that are undervalued by 20%. If we keep this strategy to ourselves, we make a lot of money. But if we publish a book with our strategy, a lot of people are going to start chasing the same 20% discounts. The more people looking for them, the harder it will be to get there first.

After missing out a few too many times, some investors decide they are perfectly happy with a 19% profit. Rather than wait for the stock to fall 20%, they jump in early so they don’t get left out again. Soon a lot of other people start doing the same thing and because of all the early buying, the stock never falls to a 20% discount.

Then some people decide 18% is good enough and they start buying even earlier. This process repeats over and over again until the discount shrinks from 20% to 10% to 5% and even 1%. The process of beating each other with the same investing strategy only stops once the profit opportunity is so small it isn’t worth the effort.

The above describes value investing, but the same process occurs in momentum stocks too. Let’s say there is a great stock screen that identifies companies with the largest profit growth. The strategy tells us to buy these momentum stocks when they breakout from a consolidation because that is when they have the most explosive upside. But soon everyone is chasing the same growth stocks at the same time and the breakout moves so fast few people can buy it before the stock is too far extended to buy safely.

Frustrated investors who get left behind a few too many times commit to buying the stock a little before it breaks out so they don’t get left behind again. It doesn’t take long before more and more investors are buying the stock before it breakouts and soon the buy early crowd is causing a breakout before the stock is ready. Without a sufficient consolidation, the breakout fizzles and tumbles back into the consolidation, triggering everyone’s stop-loss. Rather than make money using this surefire investing idea, all the followers are sitting on losses.

Every popular investing strategy stops working once too many people start using it because the crowd quickly distorts the price-action that made it work in the first place. They sucks up all the profit potential and it is hardly worth the effort. Or the crowd triggers fake breakouts that suck everyone in and then spit them out with less money than they started with.

Dogs of the Dow, value investing, momentum investing, technical analysis, candlesticks, cup-with-handle, etc, etc. When any strategy gets too popular, it stops working. The very act of people following a strategy changes it and that is enough to destroy the profit potential.

But don’t despair, there are a million different way to profit from the stock market. The key is to find a strategy that fits the way you look at the market and then add your special sauce. There is nothing wrong with starting with an existing strategy, but you must bring something extra to the process to make it profitable. Maybe you are a technophile and have a knack for knowing which products will be a hit before Wall Street figures it out. Or maybe you know which laggards are about to turn things around. Something, anything, but you absolutely must have that special sauce otherwise you are just one of clones fighting over the same $100.

In future Cracked.Market University pieces I will help you find unique ways to look at the market that will help you find your special sauce. Be sure to come back for more free CMU posts.

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Sep 26

Why smart traders ignore today’s price-action

By Jani Ziedins | End of Day Analysis

End of Day Update:

On Wednesday the S&P500 rebounded from Tuesday’s selloff but it was unable to hold those early gains and closed flat.

In a directional market, a late fizzle like this would be a big red flag. It warns us there is no follow through and support is crumbling. But this isn’t a directional market and traditional trading signals don’t apply.

We have been stuck in a predominantly sideways market most of this year and every breakout and breakdown has been a false alarm. Anyone who failed to realize this has been making the exact wrong trade at the exact wrong moment. Buying the breakout just before it fizzles and selling the breakdown just before it rebounds.

Unfortunately the market fools traders with these tricks far more often than people are willing to admit. That’s because it is nearly impossible to come to the market without a bullish or bearish bias. Many traders cognitively know the market trades sideways 60% of the time, but in the moment they always think prices are either about to take off, or on the verge of collapse.

Read any blog post or social media stream and all you see is endless bickering over whether the market is about to explode higher, or about to plummet. The rarest opinion is “meh, the market isn’t doing much and I don’t think it will do anything any time soon.”

Unfortunately for most traders these bullish and bearish biases convince them to buy the breakout or sell the breakdown, moments before prices reverse. Then they either chicken out or hit their stop-loss and lock-in their losses. To add insult to injury, prices reverse hours after the trader closes his position. Almost every single person reading this blog knows exactly what that feels like.

Buy high and sell low is a horrible way to trade the market, unfortunately it happens way more often than anyone wants to admit. Directional traders make a lot of money getting here, but they give it all back in these sideways stretches.

The above was a very long-winded way of saying, ignore today’s late fizzle because it is meaningless. Just like last week’s breakout didn’t mean anything, and the fizzle before that. We are stuck in a market that refuses to go down nearly as much as it refuses to go up. Don’t fall for these tricks by reading too much into this meaningless price-action.

While we are in a mostly sideways market, the path of least resistance is definitely higher. Headlines have been resoundingly bearish over the last several weeks and the market has flatly refused to breakdown. If this market was fragile and vulnerable to a crash, it would have happened weeks ago. The fact we withstood wave after wave of bearish headlines means this market is far more resilient than most people realize. A market that refuses to go down will eventually go up.

Keep doing what has been working. Stick with your buy-and-hold positions and add on dips. Big money returned from summer vacation and they are more inclined to buy this market than sell it. Expect this demand to prop up prices over the near-term as big money keeps buying every dip. Over the medium-term expect this resilience to pressure underweight managers into chasing prices higher into year-end. This is an old bull market, but it still has life in it. Underestimate it at your peril.

Jani

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Sep 25

The most powerful technique for analyzing the market

By Jani Ziedins | Free CMU

Welcome to the new Cracked.Market University educational series. Look for new articles every Monday and Wednesday.

Many traders approach the market by trying to predict the outcome of an event and profit the market’s expected reaction. If the Fed raises rates, then the market will respond this way. If unemployment misses expectations, the market will move that way. Cause-and-effect analysis works well in everyday life it is natural to bring this line of thinking to the market. Unfortunately this method fails to account for how markets work and this omission explains why so many people lose money.

Traders often predict the outcome of a market moving event correctly, unfortunately they are not as good at figuring out the market’s reaction. This leads to the popular misconception the market is “fixed” and “rigged”. This couldn’t be further from the truth and I will cover this fallacy in another blog post. In the meantime just take my word for it the market is an equal opportunity humiliator and does a fair and equitable job screwing over both retail and institutional investors. When you lose money, it isn’t because some cunning market villain stole your money, it’s because your analysis is missing key ingredients.

In my two decades of trading, far and away the most effective tool I use in identifying market’s next move is studying what it is NOT doing. Almost everyone obsesses over what the market is doing and tries to to fit these moves into their narratives, whether that is fundamental, technical, or a hybrid of the two.

The problem is looking at what the market is doing inevitably leads us to thinking about what it “should” be doing. When the market doesn’t do what we think it should be doing, rather than admit we are missing something, our natural instinct is to argue with the it. This response is incredibly counterproductive and leads to more lost money than every other mistake traders make.

Take the current situation with North Korea. This is obviously a bearish development and there are grave consequences for everyone involved if this situation escalates beyond words. Despite these ominous warning signs, the market continues to hover near all-time highs. This leads many people claim the market is complacent, stupid, and worse. Common sense tells us the market should have sold off dramatically on these dire headlines. But we didn’t. That mean either the market is wrong, or god forbid, we are wrong. We couldn’t possibly be wrong, so obviously the market is wrong.

Rather than acknowledge the market’s strength, these critics double down and claim it will only be time before prices crash and they are proven right. The problem is these traders are missing the incredibly powerful signal the market is giving us. This market is not selling off, not because it is stupid, but because it is unbelievably resilient and strong. There are few things more bullish than a market that refuses to go down on bad news. Everyone who is spending all their energy arguing with this market is about to get run over.

If this market was fragile and vulnerable, it would have crashed a long time ago. Rather than argue with it, we should acknowledge it. Better yet, let’s profit from it! A market that refuses to down will eventually go up.

The same thing happens on the opposite side. A market that fails to go up on good news is a clear warning of potential exhaustion. A recent example is AMZN spiking on the acquisition of WFM. Since then the stock is down 13% and it definitely looks like it is struggling to find new buyers.

Asking what is the market is not doing gives a trader great insight into which direction a stock is inclined to go. A market that refuses to go down on bad news has a lot of upside potential in it. A stock that fails to go higher despite all the praise it is getting is a clear sign new buyers are scarce and at the very least it needs to rest and consolidate recent gains.

I have a large assortment of tools and techniques I use to evaluate the market, but this is far and away the easiest, most powerful, and most profitable tool I use.

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Sep 22

Weekly Scorecard: North Korea still doesn’t matter

By Jani Ziedins | Scorecard

Welcome to Cracked.Market’s weekly scorecard:

This post includes a summary of the week’s market developments, links to the free posts I published, and analysis on how accurate each post was since I wrote it. 

Weekly Analysis:

Tensions with North Korea flared up again as Trump threatened to “Totally Destroy” North Korea in a speech to the U.N. and North Korea retaliated by threatening to test a nuclear bomb in the Pacific Ocean. Last month headlines like these sent the market tumbling 1.5%. This month the market barely flinches.

News gets priced in over time. That’s because owners who are afraid of these headlines sold weeks ago and were replaced by confident dip-buyers who demonstrated a willingness to hold these risks. Since everyone who is afraid of North Korea already bailed out, there is no one left to sell this latest round of headlines. When no one sells the news, it stops mattering and that is exactly what happened here.

The other significant development was the Fed announced it would start winding down its bond portfolio and they left the door open to a third rate-hike later this year. While both of these developments are potentially bearish, the market expected these policy decisions and they didn’t move the market. It’s been years since a Fed decision moved prices in a meaningful and sustainable way and this time was no different.

The market’s price-action has been incredibly resilient given the headline uncertainty. A market that refuses to go down will eventually go up. Keep doing what has been working and that is sticking with this bull market.

Read my daily posts for deeper insights and analysis on these topics and more.

Tuesday Sept 19th: Stick with this Bull

“As we saw today, the North Korean rhetoric no longer matters to the market and we can safely ignore it. Next item coming up is the Fed’s policy statement on Wednesday. Consensus is the Fed will start winding down its balance sheet. This is an anti-stimulus move, but the market is largely ready for it. Yellen and the Fed have done a great job telegraphing their moves to minimize disrupting financial markets. While we should expect a brief bout of volatility, it’s been years since a Fed decision affecting the market in a significant and lasting way. I don’t expect tomorrow to be any different.”

Score 10/10: This analysis was spot on. North Korean headlines failed to ignite a selloff and the market barely moved after the Fed announced exactly what everyone thought they would. Read the entire post for more insights into why the market reacted to these events the way it did.

Thursday Sept 21st: Don’t fear a routine and healthy dip

“If we are expecting the market to collapse on bad news, Thursday’s “news-less” day definitely won’t cut it. This market withstood a nearly constant barrage of negative headlines over the last month and barely sold off two-percent. If those headlines couldn’t break us, there is definitely nothing in the current news cycle that tops ballistic missile launches, nuclear bomb tests, and back-to-back hurricanes. That resilience means we can safely cross news-fueled selloff from the list of vulnerabilities. If this market was going to crash on bad news, it would have happened weeks ago.”

“As I write this, overnight futures slipped on Asian weakness. But as I said above, testing support is a normal and healthy part of moving higher. There is nothing to worry about if we dip under 2,500 support. A wave of selling might hit us as recent buyers’ stop-losses are triggered. But that selling will quickly dry up like it has every other time this year. Confident owners didn’t sell far more dire headlines last month and there is no reason to think they will start bailing out now. Confident owners keep supply tight and prop up prices. That has been happening all year-long and there is no reason to think something has changed here.”

Score 10/10: This analysis from Thursday night perfectly described Friday’s price-action. Predicting what the market will do isn’t hard if you take your time to thoughtfully think about what is happening and resist the temptation to join the crowd’s overreactions.

Cracked.Market University: Contrarian Investing: Why most people screw it up

I started a new educational series and will publish new articles each Monday and Wednesday. Sign up for Free Email Alerts to be notified when new articles are published.

“All too often people mistakenly think they are contrarian investors when all they are doing is arguing with the market. If a price is going up, they sell it. If the market is going down, they buy it. At this point many of you are scratching your head because that sounds exactly like what I described in Part 1. Isn’t it?

“Nope, not even close. Don’t feel bad, this is an easy to mistake to make and it costs a lot of smart people a lot of money every day. Contrarian investing is not going against the price or the trend. Never forget price and trend have nothing to do with contrarian investing! The only thing that matters to the contrarian is what the crowd thinks.

“More often than not the contrarian trade is actual follows the market trend and buys something that has gone “too far”. Or sells something that has gone “too low”.”

This post generated quite a bit of enthusiasm and was enjoyed by many of my followers. Click the link above to read the full post.

Knowing what the market is going to do is the easy part. Getting the timing right is where all the money is made. Have insightful analysis like this delivered to your inbox every day during market hours while there is still time to act on it. Sign up for a free two-week trial.

Have a great weekend and I hope to see you again next week.

Jani

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Sep 21

Don’t fear a routine and healthy dip

By Jani Ziedins | End of Day Analysis

End of Day Update:

On Thursday the S&P500 experienced the largest drop in over two-weeks. As dramatic as that sounds, we only lost 0.3% in a relatively benign pullback to support. This was the lowest volume day this month and the first time trade has been below average since August.

As far as pullbacks go, this one was as mild as they get. There are two ways to interpret this. Either this dip was the best bears could manage in such a resilient and strong bull market. Or these are the first cracks in what is about to become a larger selloff.

If a person thinks a bull market needs to go up every single day, they should be worried about this price-action. For the rest of us, we know markets moves in waves and down days are a normal and healthy part of moving higher. Prior to today the S&P500 was up seven out of the last eight days and a routine down day was long overdue.

The question is if this is the first signs of a larger down move? Headline wise not a lot happened Thursday. The biggest market news was a continued digesting of Wednesday’s Fed policy statement that announced the unwinding of their bond positions and the continued possibility of a third rate-hike later this year. While both of those actions are relatively bearish, the market widely expected these moves and no one was caught by surprise. We slipped a little in Wednesday’s intraday trade, but a late-day rebound put us back where we started by the close. Thursday’s dip retraced some of Wednesday’s selloff, but it didn’t undercut the lows.

If we are expecting the market to collapse on bad news, Thursday’s “news-less” day definitely won’t cut it. This market withstood a nearly constant barrage of negative headlines over the last month and barely sold off two-percent. If those headlines couldn’t break us, there is definitely nothing in the current news cycle that tops ballistic missile launches, nuclear bomb tests, and back-to-back hurricanes. That resilience means we can safely cross news-fueled selloff from the list of vulnerabilities. If this market was going to crash on bad news, it would have happened weeks ago.

The next possibility is this bull market is extended and exhausted. Markets that rally too-far, too-fast are prone to collapse because everyone who could have bought has already bought and there is no one left to keep pushing prices higher. But the thing about exhaustion tops is prices race ahead and climb at a steeper rate than the prior uptrend. Is that price-action happening here?

The last several months were a sideways consolidation that ended with a double bottom and rebound off of the 50 day moving average. That looks more like sustainable base building than overextended exhaustion.

If this market is not vulnerable to negative headlines and the recent consolidation looks more supportive than threatening, do we really think Thursday’s dip is the start of something bigger? Or just one of those normal and healthy down-days that accompany every increase in prices?

As I’ve been saying for over a month, if this market was fragile and vulnerable, we would have crashed by now. While the rate of gains is nothing to get excited about, a market that refuses to go down will eventually go up. I see no reason to think anything has changed in the last several days. That means keep doing what has been working. Continue holding your favorite positions and adding more on the dips.

As I write this, overnight futures slipped on Asian weakness. But as I said above, testing support is a normal and healthy part of moving higher. There is nothing to worry about if we dip under 2,500 support. A wave of selling might hit us as recent buyers’ stop-losses are triggered. But that selling will quickly dry up like it has every other time this year. Confident owners didn’t sell far more dire headlines last month and there is no reason to think they will start bailing out now. Confident owners keep supply tight and prop up prices. That has been happening all year-long and there is no reason to think something has changed here.

Jani

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Sep 20

Contrarian Investing: Why most people screw it up

By Jani Ziedins | Free CMU

Welcome to the new Cracked.Market University educational series. Look for new articles every Monday and Wednesday. 

Spend any time following the market and you will come across the term “contrarian investing”. For those that don’t already know, this investing strategy takes a position in the opposite direction as the larger crowd. If the crowd claims something is a sure-thing, the contrarian sells it. If the crowd is rushing for the exits before things get worse, the contrarian jumps in and buys the dip. That description is simple enough to understand, but less clear is why this counter-intuitive trading strategy works so well and how come the crowd gets it wrong so often.

The first thing to realize is the crowd’s ideas are not wrong. Wisdom of crowds is a very real and powerful phenomena that I will cover in another blog post. For the time being, trust me when I say the crowd is smarter and more insightful than any of us can ever hope to be. But where following the crowd’s ideas gets investors into trouble is these ideas are already priced-in. That means most of the profit from investing in these ideas has already been made. I will use the following basic supply and demand model to show you how this happens.

The first thing to understand is stock prices are set exclusively by active buyers and sellers. I will dig deeper into this topic in another blog post, but for the sake of this discussion, people who sit in a stock or stay on the sidelines don’t affect the price. Only traders actively trying to buy and sell the stock determine the current market price. The price they agree to is the exact balance point between supply (sellers) and demand (buyers) at that precise moment in time.

The other key concept in this illustration is people trade what they think. If an investor loves Apple and he believes the stock is going to double or triple, we can be fairly certain this investor is already fully invested in AAPL. It doesn’t matter if a trader uses intuition, fundamentals, or technicals, as soon as he is convinced a stock is a good buy and he has the money, he buys it.

But the thing to realize is no matter how much this investor believes in this stock, once he buys, he places his bet and from that point forward is simply a passenger on the market’s rollercoaster.

If this is early in the process and the investor’s point of view is unique, he can spread the word and encourage other investors to follow his lead. But as his view becomes more and more popular, it is harder to find new people who don’t already believe in the idea. At this point the crowd of believers is so large that new recruits are hard to find. Even though owners have never been more optimistic, serious problems arise when there is no new money left to buy the stock.

Remember, price is the exact point where supply and demand are balanced. If we cannot find new buyers willing to join this party, it doesn’t matter how enthusiastic the crowd is, demand shrivels up and is overwhelmed by supply. The crowd is still extremely excited about this stock’s future, but without new buyers to keep pushing the price higher, supply and demand forces punish the stock.

This is an example of a bubble forming and the subsequent climax top, but the exact same process happens in reverse during capitulation bottoms. “Sell now before things get worse”, but the scariest point is usually the bottom of the dip because that is where we run out of sellers. Once that happens, supply dries up and prices bounce. Headlines stop mattering when no one is left to sell the bad news.

While these are extreme examples of climax tops and capitulation bottoms, the same process happens to a lesser extent every day across every timeframe. It’s no secret prices move in waves and almost everyone acknowledges this on a cognitive level. Yet every time prices move too far one direction or the other, rather than acknowledge this is just a normal and healthy gyration, human emotions take over and we assume this small move is the beginning of the next big move.

We can call the previous section Part 1. This is most obvious example of contrarian investing because it goes against the market’s price trend. But just as important to the contrarian investor is Part 2, when he goes along with the market’s trend.

All too often people mistakenly think they are contrarian investors when all they are doing is arguing with the market. If a price is going up, they sell it. If the market is going down, they buy it. At this point many of you are scratching your head because that sounds exactly like what I described in Part 1. Isn’t it?

Nope, not even close. Don’t feel bad, this is an easy to mistake to make and it costs a lot of smart people a lot of money every day. Contrarian investing is not going against the price or the trend. Never forget price and trend have nothing to do with contrarian investing! The only thing that matters to the contrarian is what the crowd thinks.

More often than not the contrarian trade is actual follows the market trend and buys something that has gone “too far”. Or sells something that has gone “too low”.

I will use AMZN as an example. Two years ago the stock was “unbelievably expensive” at $400 and its valuation was widely viewed as “unsustainable”. Yet today AMZN is trading near $1,000! How did that happen? Quite simply,  the crowd didn’t believe in Amazon. Rather than have too many people buy the stock at $400, too few people were buying it and there was a lot of upside opportunity left in it.

Never forget contrarian investing is going against the crowd, not the price. Don’t make that costly mistake when you are tempted to short something that is “too high”, or buy something that is “too low”. More often than not the right trade is the exact opposite of the one you want to make. That’s because our primal instinct compels us to become a member of the crowd and believe what the crowd believes. This is a fascinating topic that I will save it for another post. Stay tuned!

I’m excited about this new series because my head is overflowing with ideas and insights that came from two-decades of trading experience. I hope you come back for the next post. 

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Sep 19

Stick with this Bull

By Jani Ziedins | End of Day Analysis

End of Day Analysis:

The S&P500 added to last week’s breakout and continues its steady ascent into record territory. A tenth-of-a-percent is definitely not setting the world on fire, but these slow and deliberate gains tell us there is strong support behind these prices.

Rather than take profits near prior resistance, most owners are confidently holding for higher prices. While conventional wisdom warns us about complacent markets, what it fails to mention is periods of complacency last far longer than anyone expects. Confident owners don’t sell dips and the resulting tight supply props up prices. That description fits this market to a tee and I don’t see a reason for that to change anytime soon.

Several weeks of bearish headlines failed to dent this market and Trump was at it again Tuesday, telling the UN he will “Totally Destroy” North Korea. But by market standards, this is already old news and it barely reacted to those provocative headlines. Clearly these headlines matter to geopolitics, but they no longer affect the market because anyone who fears these North Korean headlines sold weeks ago. These nervous sellers were replaced by confident dip buyers who demonstrated they are not afraid of these headlines. When no one is left to sell the bad news, it stops mattering.

A market that fails to go down on bad news creates a powerful buy signal. It means the path of least resistance is higher and prices will pop once the flow of bad news abates. That is exactly what happened last week when we surged to record highs. While it is easy to say this after it already happened, readers of this blog knew this rebound was coming several weeks ago.

Going against the crowd and buying when everyone else is running scared is hard to do, but that is the best way to make money in this business. Keep your cool by carefully analyzing the headlines and price-action. The thing to remember is trends continue countless times, but they reverse only once. Keep that in mind every time someone tries to convince you this time is different. Without a doubt they will eventually be right, but they will be wrong an awful lot before that happens.

As we saw today, the North Korean rhetoric no longer matters to the market and we can safely ignore it. Next item coming up is the Fed’s policy statement on Wednesday. Consensus is the Fed will start winding down its balance sheet. This is an anti-stimulus move, but the market is largely ready for it. Yellen and the Fed have done a great job telegraphing their moves to minimize disrupting financial markets. While we should expect a brief bout of volatility, it’s been years since a Fed decision affecting the market in a significant and lasting way. I don’t expect tomorrow to be any different.

If this market was fragile and vulnerable to a crash, it would have happened by now. Last month’s dip and consolidation refreshed the market and gave us a solid foundation to build on. That said, the market likes symmetry and last month’s small and short dip will lead to an equally unimpressive rebound. We’re already most of the way there and it will take something new to keep prices rising.

Luckily there are a lot of recent sellers and underweight money managers under pressure because they are missing this rebound. Soon the fear of a selloff is going to be replaced by fear of being left behind. Expect this chase for performance to fuel a strong rally into year-end.

As I said previously, if we were going to crash, it would have happened by now. Markets don’t move in straight lines and expect volatility to continue, but the path of least resistance is definitely higher. Stick with what has been working: buy-and-hold and jumping on each dip.

Jani

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