Finding the right risk/reward

End of Day Update:

After a little up and a little down, the S&P500 ended Tuesday right where it started. Early strength gave way to midday selling, which was followed by a late surge back to breakeven. As dramatic as that sounds, the price swings barely got larger than one or two tenths of a percent. For all practical purposes, nothing much happened on this largely indecisive and irrelevant day.

That said, spending another day at or near all-time highs shows there is still good support behind this market. There is very little chasing going on since breakouts to record highs stall within hours, but confident owners have zero interest in selling no matter what the headlines and price-action are. Their refusal to sell keeps supply tight and makes it easy to hold these levels.

As I wrote last week, if this market was going to tumble on disagreements within the Republican party, it would have happened by now. I viewed this as the biggest headline risk to this extended rally, but so far the market doesn’t care. If the market doesn’t care, then neither should we. It is tempting to get stubborn and argue with the market in these situations, but that only leads to bigger losses. Right or wrong, the market is bigger than we are and it will run over us if we get in its way.

Even though the path of least resistance continues to be higher, only two kinds of traders are making money these days. Buy-and-hold investors who ignore all the noise. And the most nimble of day-traders. For the rest of us, these ultra-small daily fluctuations don’t give us much to trade. When confident owners don’t sell, dips don’t happen. When people don’t sell the dips, there is no one scrambling to get back in during the rebound. Without emotion on either side, volatility shrunk to a level where most days moves are measured in single tenths of a percent. Buying a 0.1% dip in anticipation of a 0.1% rebound doesn’t make a lot of sense for me and my style of trading.

My favorite trades occur when fear and uncertainty consume the crowd. That is when sellers offer steep discounts so they can “get out before things get worse.” Unfortunately for those emotional and reactive sellers, the dip ends not long after they bailout. Fortunately for me, their pain is my gain. (God, I miss those days.) Now we find ourselves at the opposite end of the spectrum. Confident owners refuse to sell for any reason and the few that are willing to deal demand steep price premiums. The path of least resistance is clearly higher, but there is not much margin for error when paying premium prices.

Everyone knows the market moves in waves. Unfortunately most forget that just as the latest wave is cresting. While I’m not calling a top here, I know we’ve done a lot of up without much down. The last meaningful dip was nearly three months ago. The next one is coming, the only thing we don’t know is if it will happen this week, next week, or next month. But with each passing day, it is closer than it has ever been.

Anyone can get lucky and make money on a single trade. But success over the long-term depends on buying when the risks and rewards are in our favor. Given how small the near-term upside is and how much air there is underneath us, it is hard to claim buying at these levels presents a trader with a good risk/reward. Long-term investors should ignore the noise and stick with their favorite stocks, but short-term traders should wait for a better risk/reward.

The biggest upside catalyst is Republicans reaching an agreement on Tax Reform. Given how far apart the views are, Trump’s Thanksgiving deadline seems highly unlikely. Even Christmas would be a stretch and require a lot of things falling into place. Until then, at best the market keeps inching higher. At worst traders get spooked and we test support. Small reward, large risk. You decide how to trade that.

Jani

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