Category Archives for "Free Content"

End of Day Update:

On Tuesday the S&P500 tried to recover Monday’s selloff, unfortunately the follow through never materialized and we finished well off the intraday highs. Traders still seemed more inclined to take profits than buy the dip.

If this market was poised to rip higher, this was the bulls’ opportunity. The lackluster buying suggests this weakness will likely extend past Monday’s dip. But this isn’t a bad thing. The recent runup leaves us 70-points above the 50dma and a check back is long overdue. The only question is if we dip back down to this key moving average, or trade sideways and allow it to catch up.

Falls from unsustainable levels typically happen quickly, so the longer we hold current levels, the more likely a sideways consolidation becomes. But we need a few more days because two-days definitely doesn’t qualify as solid support.

Last Friday we broke out to record highs when the Senate finally agreed on a budget. That clears the way for more significant Tax Reform. Unfortunately those fuzzy feelings didn’t last long and rifts within the Republican party started showing as Trump and key Senators started throwing barbs at each other. Trump definitely has a more antagonistic leadership style and that will likely lead to more tension during the Tax Reform debate. The market hates uncertainty and this conflict will likely erase a big chunk of the hope that lifted us to these levels.

I’m most definitely not a bear and still think the path of least resistance over the medium-term is higher. But I have also been doing this long enough to know the market doesn’t move in straight lines. After a period of nice gains, it is perfectly normal for the market to consolidate the runup. This is part of the healthy process of moving higher. In fact I would be more concerned about the sustainability of this rally if we didn’t consolidate recent gains. The higher we go, the harder we fall when the inevitable consolidation eventually happens.

All of this means this is definitely a better place to be taking profits than initiating new positions. But just like how we shouldn’t overreact to recent strength, the same level-headed thinking will be required if we dip further over the next several days. Additional weakness is creating a buying opportunity, not an excuse to reactively abandon an otherwise healthy market. Remember, smart money trades proactively by selling strength and buying weakness. Reactive traders bleed themselves dry by doing the opposite they buy high and sell low. Don’t be a reactive trader.

Jani

Oct 22

Weekly Scorecard: History is not on the Bull’s side

CMU: Why most traders screw up counter-trend trades

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

It was another strong week for the S&P500. This was the sixth consecutive weekly gain and the eighth out of the last nine. For historical perspective, only one other stretch since Trump’s election strung together six up-weeks. Unfortunately the next week started a 70-point pullback. The question on everyone’s mind is, “How many more weeks can this keep going?”

The attached chart shows the market’s waves over the last 12-months. Five periods of up followed by sideways and/or down. When prices dipped to the 50dma, the consolidation tended to be brief. The times we didn’t dip, the market traded sideways until the moving average caught up before staging the next leg higher.

Currently we are approximately 80-points above the 50dma. Early in the rally we found ourselves as high as 100-points above the 50dma before peaking. Other times we stalled 40-points above the 50dma. 80-points is definitely on the higher end of the range, but not the most extreme and it is possible we could go a little higher. But it would break precedent if we went a lot higher.

Bulls are definitely getting cocky and my last few posts generated a fair bit of criticism when I suggested this was a better place to be taking profits than adding new positions. But this is actually a good thing and I find their criticism reassuring because I get nervous when too many people agree with me. Without a doubt momentum can keep this rally going for a few more days or weeks, but history tells us we are definitely close to the end of this ride. Famous last words often start with, “This time is different.”

And to be clear, I’m not bearish nor am I predicting a crash. The 50dma is a little too far away and we either need to pause and let it catch up, or we dip back down to it. Nothing more, nothing less.

October 19th: Why smart money will sell the Senate’s budget

If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.

There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.

That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.

There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.

There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.

Score To Be Determined: We won’t know how accurate this analysis is for several weeks, but I haven’t seen Congress pass meaningful legislation without relentless bickering and infighting. And that is a normal Congress. This group of Republicans is even more fractured and divided than normal. I would be shocked if Tax Reform progresses smoothly and we should be prepared for the volatility this heated debate will trigger.

October 17th: Why bulls need to be careful

For those of us that are paying attention, this looks a lot like a lethargic wedge higher and suggests this market is running out of gas, not on the verge of exploding higher. Explosive moves are by definition explosive. A tiny trigger blossoms into in a much larger move. Sometimes it is an unexpected headline, other times a technical breakout. But something triggers a surge of buying and away we go.

Unfortunately this wedge higher is the opposite of explosive. We keep getting good news. Today the Trump administration said they wouldn’t put conditions on repatriated profits and companies could use their newly liberated cash for dividends and buybacks. More cash in shareholders’ pockets is always a good thing. Then there was the technical the breakout as we moved into record territory. The cumulative result of both of these bullish developments, a measly 0.07% gain. Something so small it doesn’t even qualify as a rounding error.

Every day bulls are trying to push us higher, but the gains are getting smaller and smaller. That reeks of exhaustion, not unbridled potential. Without a doubt it is encouraging we managed to hold recent gains. Typically markets tumble from unsustainable levels quickly. This strength comes from owners who are confidently holding for higher prices and few are taking profits. Their conviction keeps supply tight and props up prices. Unfortunately propping appears to be the best bulls can manage. We need new buyers to keep this rally going and right now those with cash are reluctant to chase prices any higher.

Score 7/10: The market popped 0.5% Friday following the Senate passing a budget. By itself this event doesn’t mean a lot, but it brings us one step closer to Tax Reform. I still believe this will be a bumpy road, but any progress is good. The market is up 15-points from when I wrote this post so I docked myself a few points, but I still think the analysis is valid. The true test will come next week when we either extend Friday’s gains, or that breakout fizzles and we slip back to 2,550. Most likely prices fizzle, but there is a chance a frenzy of buying sends us dramatically higher. But the higher we go without consolidating gains, the harder we fall when it finally happens.

Cracked.Market University

Excerpts from my educational series. Click the title to read the full post. Signup for Free Email Alerts to be notified when news posts are published.

Counter-trend trades are one of the hardest ways to make money.That’s because traders fight an uphill battle and their timing needs to be flawless, otherwise they get run over. Despite these overwhelming odds, all too often traders cannot resist the temptation to argue with the market. In this post I will help you understand why counter-trend trading is so difficult, when it is okay to go against the trend, and the risks you face when doing it. Knowledge is power and the more you know going in, the better chances you have of coming out the other side alive, and maybe even with a little extra money in your pocket.

CMU: Are You a Victim of Beginner’s Luck?

Unfortunately beginner’s luck is not sustainable and all too often trader’s mistakenly believe their early good fortune was due to skill, not luck. Rather than dig in and learn from more experienced traders, they assume they have this game figured out and don’t need any help. Their early success convinced them they already know everything they need to know. Only after they lose their first stake do they start looking for outside guidance.

If you are reading this, most likely you experienced some early success and that encouraged you to keep at it. But now things have gotten harder and losses are more common than profits. While it hurts, realizing trading is not easy is actually a good thing. And if you figured this out early, count yourself lucky. Traders who experiences too much early success keep upping the size of their trades until inevitable fall goes from emotionally demoralizing, to financially ruinous.

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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Oct 19

Why smart money will sell the Senate’s budget

End of Day Analysis:

The S&P500 fell out of bed Thursday morning when it started the day with the biggest losses in over a month. But within an hour supply dried up and dip buyers rushed to our rescue. Not only did we finish off the early lows, we actually managed to close in the green. That said, volume was unremarkable given how dramatic the price-action was.

This was an impressive reversal and it leaves us wondering what it means. Decisive reversals are often strong buy signals when they follow multi-day selloffs and the rebound occurs following yet another piece of bad news. Selling capitulates when then the crowd is most uncertain and fearful. That is when the last of the nervous sellers bail out and moments later prices rebound when there is no one left to sell. Unfortunately that setup looks nothing like today’s dip and rebound.

Things got more interesting late Thursday evening when the Senate passed a budget. While it was nice to finally see something not crash and burn in the Senate, the budget is largely a procedural matter and really doesn’t count for anything. The only significant thing is it allows Republicans to avoid a Democrat filibuster when voting on their yet to be announced Tax Reform Bill. Overnight futures popped 0.3% on the encouraging developments.

So what is a trader to do on Friday? Thursday’s intraday rebound appears constructive. Then you have the good news coming out of the Senate. Most likely the best plan is to sell the news. There are a couple of reasons why.

The easiest to explain is politics. If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.

There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.

That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.

There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.

There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.

Next comes the market’s price-action. As I’ve been writing about for the last two-weeks, the market is extended and needs to consolidate recent gains. Everyone knows markets move in waves and we are near the upper end of the latest wave. I’m definitely not predicting a crash, but catching our breath is a normal and healthy thing to do following a 100-point move from last month’s lows.

The market is fatigued and this is easily seen in the lethargic breakouts to record highs. Gains of 0.18%, 0.07%, 0.07%, and 0.03% over the previous four days show how little interest there is in buying the record highs. If there was explosive upside left in this rally, we would have raced higher by now. Instead these insignificant “breakouts” tell us demand is drying up.

Don’t get me wrong, I’m not bearish, just realistically cautious. Consolidations are a normal and healthy part of moving higher. The quickest way to refresh a market is pulling back to support. The longer way is drifting sideways for an extended period and allowing the trend lines and moving averages to catch up. Either one will work for this market and only time will tell which one we get.

I’m most definitely not calling a top here, just warning that the upside is more limited than the downside. Long-term investors should stick with their favorite positions, but shorter-term traders need to think about locking-in profits and waiting for better prices.

Jani

Oct 18

CMU: Why most traders screw up counter-trend trades

Cracked.Market University

Counter-trend trades are one of the hardest ways to make money.That’s because traders fight an uphill battle and their timing needs to be flawless, otherwise they get run over. Despite these overwhelming odds, all too often traders cannot resist the temptation to argue with the market. In this post I will help you understand why counter-trend trading is so difficult, when it is okay to go against the trend, and the risks you face when doing it. Knowledge is power and the more you know going in, the better chances you have of coming out the other side alive, and maybe even with a little extra money in your pocket.

As I wrote in a previous educational post, most traders don’t understand contrarian investing. Too many people mistakenly believe contrarian trading is going against the trend. Nope, the trend has nothing to do with it. Contrarians go against the crowd, not the trend. Big, big difference and if you are a little unsure, check out my previous post.

There is nothing wrong with a stock or index that goes up. That’s how the S&P500 went from 100 to 200, 500 to 1,000, and why we currently find ourselves above 2,500. If an investor knows nothing else, smart money bets on the market going higher because that is what it does. Blame inflation, productivity, money printing, or anything else, it doesn’t really matter. Markets go up more than they go down and that’s all that matters to the long-term investor.

But we’re traders and we want to trade. We don’t want to sit idly through every gyration. Not only do we want to skip the next pullback, we want to profit from it by shorting the decline. Everyone knows markets go down, especially after it goes up “too much”. Unfortunately that overly simple logic costs a lot of smart people a lot of money.

Markets move in waves and I cover this another educational post, but suffice to say every bit of up is followed by a normal and healthy bit of down. Trading these waves is not a bad thing as long as we keep selling high and buying low. Unfortunately that is a lot easier to say than it is to do.

For beginners, the best way to swing-trade is to ride the wave up, sell when after a nice run, and then wait to buy the next dip. This way you are always trading alongside the trend. If you buy a little too early or late, it doesn’t really matter because mistakes are fixed by waiting it out. Did the market keep going down after you bought the dip? No problem, just wait for the rebound to erase your losses. Hold a little too long and the market fell under your buy point? No worries, simply wait for the next wave higher.

Counter-trend traders don’t have these same protections. If they screw up and don’t exit immediately, the losses only get bigger as the market marches away from them. Short an uptrend at the at the wrong time and the more stubborn you are, the more money you lose.

I will be honest, I short bull markets. But I also acknowledge this is a low-probability trade and am doing it more for entertainment than to make money. But as long as I pick the right entry point, the risks are manageable.

The key to surviving counter-trend trades is to assume a trend will continue and it requires proactive timing. Short a move to the top of the range, not a violation of the lower end. As I said earlier, markets move in waves and the best short opportunities are when everyone is fat and happy. By the time traders are nervous and the headlines dire, it is too late. At that point a smart traders is thinking about buying the dip, not shorting the weakness. And when counter-trend trades show a profit, get paranoid of a rebound and start looking for an excuse to cash-in.

Remember trends continue countless times, but they reverse only once. The odds always favor a continuation of the previous trend and smart traders stick with the high probability trade.

There are ways to identify a trend that is dying and about to reverse. That sounds like an excellent topic for another blog post! Signup for Free Email Alerts so you don’t miss it.

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Oct 17

Why bulls need to be careful

End of Day Update:

The S&P500 closed at yet another record high on Tuesday. Never mind the fact we only moved 0.07% above Monday’s record close, which was up only 0.18% from Friday’s close. Records are records and today counts…right?

For those of us that are paying attention, this looks a lot like a lethargic wedge higher and suggests this market is running out of gas, not on the verge of exploding higher. Explosive moves are by definition explosive. A tiny trigger blossoms into in a much larger move. Sometimes it is an unexpected headline, other times a technical breakout. But something triggers a surge of buying and away we go.

Unfortunately this wedge higher is the opposite of explosive. We keep getting good news. Today the Trump administration said they wouldn’t put conditions on repatriated profits and companies could use their newly liberated cash for dividends and buybacks. More cash in shareholders’ pockets is always a good thing. Then there was the technical the breakout as we moved into record territory. The cumulative result of both of these bullish developments, a measly 0.07% gain. Something so small it doesn’t even qualify as a rounding error.

Every day bulls are trying to push us higher, but the gains are getting smaller and smaller. That reeks of exhaustion, not unbridled potential. Without a doubt it is encouraging we managed to hold recent gains. Typically markets tumble from unsustainable levels quickly. This strength comes from owners who are confidently holding for higher prices and few are taking profits. Their conviction keeps supply tight and props up prices. Unfortunately propping appears to be the best bulls can manage. We need new buyers to keep this rally going and right now those with cash are reluctant to chase prices any higher.

Everyone knows the market moves in waves and it is obvious from the chart this market is at the upper end of its range. I still believe in this bull market and am most definitely not a perma-bear predicting a crash. But I recognize when the market gets ahead of itself and needs to consolidate recent gains. Without a doubt we reached a point where we need to cool off.

The quickest way to consolidate recent gains is dipping back to support. That is a normal and healthy way to reset the clock and clear the way for a continuation higher. The slower route is trading sideways for a longer period of time and allowing the trend lines and moving averages to catch up. We’re only a couple of weeks into this sideways trade and it would take several more weeks of treading water before we come close to consolidating recent gains. As a point of reference, the 50dma is still 70-points underneath us.

Strictly looking at the market dynamics, at best we trade sideways for several weeks. Worst we dip back to 2,500 support. Either way this is not a great time to be putting new money into the stock market.

If we move beyond the market and consider looming headlines, Republicans are making good progress toward tax reform. Without a doubt this encouraging news contributed to recent gains. But it doesn’t take a political science degree to know these negotiations get ugly, often to the point of crushing all hope moments before a deal is finally reached. That is standard operating procedure for Congress and we should expect more of the same here.

Republicans are currently in the brainstorming phase where everything and anything goes. But soon they will transition to the compromise stage where opposing sides and special interests dig in and threaten to blow the entire thing up if they don’t get their way. It is only time before the current feelings of hope for tax cuts devolve into cynicism. Most likely that shift in sentiment will be the catalyst that triggers a pullback to support.

Without a doubt our politicians could unexpectedly announce fair and reasonable tax reform ahead of schedule, but I certainly wouldn’t bet my money on it. Between the price-action and the headline environment, I suspect the next few weeks will be a lot more challenging for the stock market.

Buy-and-hold investors should stick with their favorite stocks, but shorter-term traders should look for opportunities to lock-in profits and the most aggressive can think about shorting. That said, the path of least resistance is still higher and any dip should be bought. This will be nothing more than a normal and healthy dip on our way higher.

Jani

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Oct 16

CMU: Are You a Victim of Beginner’s Luck?

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

CMU: Are You a Victim of Beginner’s Luck?

Hang around trading circles and you inevitably hear of a phenomena called beginner’s luck. This is where a new person experiences unusually good fortune. How can a new person be more lucky than the experienced traders around him? Let’s investigate.

Statistics make a compelling argument a beginner has no better odds of success in a game of chance than someone who has been doing it for a while. Let’s simplify it to a game of betting on a coin-flip. If he predicts heads and the coin lands heads, he wins. If the coin lands tails, he loses. Simple enough.

Assuming a fair coin and toss, we would expect the outcome to be totally random for both the novice and the experienced coin-flip guesser. If there is zero ability to predict the outcome, skill has nothing to do with it and the result is down to random luck. Under these rules, a beginner and an experienced coin-flip guesser will have same level of success, on average winning half the time. Despite superstitious beliefs to the contrary, in games of chance a beginner has no more opportunity to be lucky than the experienced coin-flip guesser.

In a game of skill, you would definitely expect a more experienced participant to do better than a novice. An 18-year-old who has been playing football since he was six would most likely enjoy more success in a pickup football game than another 18-year-old foreigner who has never seen a football game.

It doesn’t take a genius to know the more you practice something, the better you get. This makes sense and no doubt applies to trading. But the skill that comes from experience implies the exact opposite of beginner’s luck. In most instances the novice will vastly underperform the experienced professional.

So where does this notion of beginner’s luck come from? Is there a way it can still be true despite these logical and compelling arguments against beginner’s luck?

The one thing we haven’t considered yet is human nature. A person who loses a lot of money in their first handful of trades will most likely quit in disgust. After losing $5k, $10k, or $20k in their first handful of trades, they will most likely come to the conclusion the market is rigged and it cannot be won. They quit and never look back.

But the opposite is true for a person who experienced early success. If a person makes $5k, $10k, or $20k on their first few trades, they think they have a knack for trading and become addicted to the thrill of winning. Without a doubt the people who experience early success are far more likely to stick with it and keep coming back. That early success will even convince traders to stick with it after a period of losses because in their heart they know they are good at this. It is only a matter of time before their cold streak ends and their luck improves.

So while it is true a beginner has no better odds of success in a game of chance, and a worse odds of success in a game of skill, beginner’s luck is still a very real phenomena in trading circles. That is because of survivor’s bias. Early losers quit and only the traders who enjoyed early success stuck around. Tha means in any groups of experienced traders, most of them started with a hot streak.

Unfortunately beginner’s luck is not sustainable and all too often trader’s mistakenly believe their early good fortune was due to skill, not luck. Rather than dig in and learn from more experienced traders, they assume they have this game figured out and don’t need any help. Their early success convinced them they already know everything they need to know. Only after they lose their first stake do they start looking for outside guidance.

If you are reading this, most likely you experienced some early success and that encouraged you to keep at it. But now things have gotten harder and losses are more common than profits. While it hurts, realizing trading is not easy is actually a good thing. And if you figured this out early, count yourself lucky. Traders who experiences too much early success keep upping the size of their trades until inevitable fall goes from emotionally demoralizing, to financially ruinous.

I’m glad you found this blog and my goal is to help other traders learn from my years of struggles and successes. No matter what the late night infomercials claim, trading is hard and it takes work. The first step is educating yourself. The second step is gaining firsthand experience by trading smaller sizes. The goal isn’t to make money, but to learn how to trade. The best way to approach the market in the beginning is viewing your account as the amount you are willing to pay in tuition. If you have $100k, start trading $20k. If you have $10k, start trading $2k. This way when you get wiped out, you have the ability learn from your mistakes and start over. Give yourself enough time to learn from your mistakes and your chances of success go way up.

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Oct 06

Weekly Scorecard: Tread lightly

CMU: The obvious trade everyone screws up

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

The S&P500 surged to record highs this week, breaking through 2,550 in Thursday’s trade. But the first employment losses in seven-years dampened the mood on Friday, giving us the first down day in nearly two-weeks.

As good as things feel, we must remember markets cannot go up every day. Thursday’s gains were the eighth in a row and sixteenth out of the last nineteen. A down day was inevitable, the question is if Friday’s 0.1% dip is enough to refresh the market and set the stage for a continuation higher.

A big chunk of this week’s enthusiasm stemmed from Republicans making progress toward tax reform. That was enough to put people in a buying mood and the early strength triggered a wave of reactive breakout buying and short-covering.

The thing we have to be careful of is Republicans are still in the brainstorming phase of crafting this bill. Next they need to figure out what compromises are required to make this thing work. That is where things get difficult. Healthcare reform went well….until it didn’t. There is a good chance the same will happen here and this week’s optimism could easily turn into next week’s pessimism.

At this point I don’t think there is a lot of upside left in this move. The only question is if we pullback to support, or we consolidate recent gains by trading sideways. There is no reason to sell long-term positions to avoid a near-term dip. Shorter-term traders should be thinking about taking profits. And those with cash should resist the temptation to chase prices higher. That said, the path of least resistance is still higher and every dip is buyable.

October 3rd: Is it finally safe to buy?

Without a doubt the path of least resistance is higher, but we know markets don’t move in straight lines. We need to mix in a few down days to keep this market healthy and sustainable. When a red-day happens, don’t freak out and start calling a top. If this market was going to crash, it would have happened weeks ago when headlines and sentiment were far more dire. Instead, expect the rate of gains to slow and for the market to spend a few weeks consolidating recent gains. We can keep going up for a few more days, but the higher we go, the harder we fall during the normal and healthy down wave. But either way, this is definitely a better place to be taking profits than adding new positions. Buy-and-hold investors can keep holding, but traders with profits should start thinking about locking them in, and those with cash should resist the temptation to chase.

Score 8/10: I knew momentum could carry us higher over the next few days and that is what happened. But this is still a better place to be taking profits than buying new positions. I docked myself a couple of points because we still don’t know how this trade will turn out. If the surge higher fizzles next week, then I can boost my score. If we keep surging higher, then I will take off a few points. The important thing to keep in mind is I am not calling a top, just saying the risk/reward has shifted against us. The upside remaining above us is far less than the downside below us.

October 5th: What smart money is doing here

To be brutally honest, only and idiot would buy the eighth consecutive up-day and seventeenth out of the last twenty. As I wrote in yesterday’s free educational piece, everyone knows markets move in waves, unfortunately most forget that fact when planning their next trade. Just as I knew August’s selloff was unsustainable, I also know this surge higher is not sustainable.

Over the last two-weeks the market has been wedging higher. This is the least sustainable price pattern. The shape is formed by desperate breakout buying and short-covering. Two of the most powerful, but least sustainable forces in the market. Once these smaller groups run out of money, most of the time there is no one left to fill the void. Big money hates chasing prices higher and almost always waits for a dip. In a self-fulfilling prophecy, big money’s reluctance to chase prices creates the lack of demand that causes prices to dip.

Without a doubt we can coast higher for a few more days, but dips are a normal and healthy part of every move higher. Without periodic pullbacks, foundations are weak and prone to failure. The higher we go over the near term, the harder we fall. I am in no way predicting a market crash and I still believe in this bull market, but I know what sustainable rallies look like and this is not it. At best we trade sideways for several weeks and consolidate recent gains. Worst case is we test 2,500 support and even dip a little under it. While not a big deal for most of us, that will be a painful ride or anyone who bought these record highs.

Score 8/10: Friday was technically a down day, but 0.1% really doesn’t count following such a large rally. The lack of profit-taking tells us most owners are confidently holding for higher prices. That keeps supply tight, but supply is only half the equation. Big money tends to fear heights and their lack of buying could cause us to drift lower. But don’t expect us to fall too far. There are a lot of managers desperate to get in this market and they buy any and all dips. It is still a little early to score this week’s analysis and next week’s trade will be a lot more insightful.

Cracked.Market University

Excerpts from my new educational series. Click the title to read the full post. Signup for Free Email Alerts to be notified when news posts are published.

The problem is most traders convince themselves every move higher or lower will continue indefinitely. When the move goes the direction of their bias, their confidence swells as the market’s price-action confirms their ideas. This confidence causes them to rush headfirst into a big position before they miss the trade they have been waiting for. Unfortunately most of the time their confidence doesn’t come until the market has already made a sizable move in the direction of their bias. In the bull’s case, when the market is making a higher-high. The problem is confidence is highest just as the last of the buyers are rushing into the market and prices are about to slip back into the trading range.

When a new trade falls into the red so quickly, confidence is shattered and replaced by uncertainty and fear. Traders initially convince themselves they can hold through a brief pullback because they are still believe they are right. When that doesn’t happen, doubt grows until vulnerable traders bail out because the pain of regret grows too strong. This selling pressures prices further, causing more nervous owners to sell, further pressuring prices. The downward spiral continues until we exhaust the supply of nervous sellers. Unfortunately for these reactive sellers, prices rebound not long after they bailout.

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

Jani

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Oct 05

What smart money is doing here

End of Day Update:

The S&P500 surged to all-time highs, making this the seventh consecutive up-day and sixteen out of the last nineteen. There was no headlines to speak of, but traders were encouraged by Republicans making progress toward tax reform.

What a difference a few weeks makes. Not long ago the market was gripped with fear and predictions of a crash were around every corner. Many traders sold defensively “before things get worse”. Luckily readers of this blog knew better than to overreact to what turned out to be benign headlines.

As I wrote many times over the last several weeks, a market that refuses to do down will eventually go up. And that is exactly what happened. A relentless barrage of bearish headlines failed to dent this bull. That told us the path of least resistance was still higher and once the storm clouds dissipated, stocks surged on “no news is good news”.

Now that we are well over 100-points above August’s lows, traders that missed the rebound are wondering what to do. The looming question if there is still time to jump aboard this rebound, or if it is too late.

To be brutally honest, only and idiot would buy the eighth consecutive up-day and seventeenth out of the last twenty. As I wrote in yesterday’s free educational piece, everyone knows markets move in waves, unfortunately most forget that fact when planning their next trade. Just as I knew August’s selloff was unsustainable, I also know this surge higher is not sustainable.

Over the last two-weeks the market has been wedging higher. This is the least sustainable price pattern. The shape is formed by desperate breakout buying and short-covering. Two of the most powerful, but least sustainable forces in the market. Once these smaller groups run out of money, most of the time there is no one left to fill the void. Big money hates chasing prices higher and almost always waits for a dip. In a self-fulfilling prophecy, big money’s reluctance to chase prices creates the lack of demand that causes prices to dip.

Without a doubt we can coast higher for a few more days, but dips are a normal and healthy part of every move higher. Without periodic pullbacks, foundations are weak and prone to failure. The higher we go over the near term, the harder we fall. I am in no way predicting a market crash and I still believe in this bull market, but I know what sustainable rallies look like and this is not it. At best we trade sideways for several weeks and consolidate recent gains. Worst case is we test 2,500 support and even dip a little under it. While not a big deal for most of us, that will be a painful ride or anyone who bought these record highs.

Friday we get the monthly employment report. It’s been years since employment moved the market in a meaningful way and this month will not be any different. In fact this month’s employment report is even less meaningful because it will be distorted by Harvey and Irma. With the two hurricanes as an excuse, traders will be able to rationalize whatever they want to about Friday’s numbers.

Buy-and-hold investors can stick with their positions, but traders should really be thinking about locking in profits, and those with cash should definitely resist the temptation to chase. Even though we might coast higher, it is only a matter of days before the market pulls back under current levels. I don’t expect a crash, but we definitely need to cool off.

Jani

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Oct 04

CMU: The obvious trade everyone screws up

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

Everyone knows the market moves in waves. Unfortunately most traders forget this important fact when planning their next trade.

All of us come to the market with biases. Extrapolating trends is human nature and we cannot help ourselves. Bulls insist the economy is fine and the rally will continue for as far as the eye can see. Bears believe wholeheartedly the economy is a sham, the market has gone too-far, too-fast, and we are on the verge of collapsing.

While all of us feel one way or the other, the question we must ask ourselves is how often does the market actually rally for as far as the eye can see? How frequently do prices collapse? If these are such rare events, why do most traders think extreme events are around every corner? The rarest predictions is the market will go a little higher before it goes a little lower, or a little lower before it goes a little higher. Who dares make such boring predictions?

I have read claims the market trades sideways 60% of the time. While I haven’t verified it myself, twenty-years of experience trading stocks tells me this number is definitely in the ballpark. Prices go up for a while, then they go down for a bit. Sometimes they make higher highs, other times lower lows, but the market always moves in waves.

The problem is most traders convince themselves every move higher or lower will continue indefinitely. When the move goes the direction of their bias, their confidence swells as the market’s price-action confirms their ideas. This confidence causes them to rush headfirst into a big position before they miss the trade they have been waiting for. Unfortunately most of the time their confidence doesn’t come until the market has already made a sizable move in the direction of their bias. In the bull’s case, when the market is making a higher-high. The problem is confidence is highest just as the last of the buyers are rushing into the market and prices are about to slip back into the trading range.

When a new trade falls into the red so quickly, confidence is shattered and replaced by uncertainty and fear. Traders initially convince themselves they can hold through a brief pullback because they are still believe they are right. When that doesn’t happen, doubt grows until vulnerable traders bail out because the pain of regret grows too strong. This selling pressures prices further, causing more nervous owners to sell, further pressuring prices. The downward spiral continues until we exhaust the supply of nervous sellers. Unfortunately for these reactive sellers, prices rebound not long after they bailout.

On the other side, bears have been emboldened by this dip and they start loading up on shorts just as the market starts making fresh lows. Their predictions of a collapse are coming true and they don’t want to miss out on all the money they will make. Yet just like the bulls, their timing is all wrong and no sooner than they jump in, prices rebound and they start losing money.

These waves of greed and fear occur in every timeframe from minutes to years and they suck in novices and pros alike. But it isn’t all bad. The stock market is largely a zero-sum game, meaning one person’s loss is another person’s gain. Those of us who us who understand the psychology behind these moves and can control our impulses profit by selling greed and buying fear. While that sounds easy, executing it successfully is one of the hardest things to do in trading.

The problem is we are herd animals and our survival instincts wired us to adopt the mood of the crowd around us. When everyone is happy, those feelings of calm and complacency are hard to resist. When everyone is scared, we grow fearful and the fight/flight instinct dominates our thoughts.

The most important thing to remember about dips is they always feel real. If they didn’t, no one would sell and the market wouldn’t dip. Cognitively acknowledging most dips bounce is the first step in overcoming our primitive instincts. Same goes for surges in price. Just when everything feels the most safe is when we should be the most nervous.

In August the crowd was predicting doom-and-gloom. They were wrong. Several weeks later we are making new highs and everything looks good. That said, I have little doubt these gleeful bulls will prove to be as wrong as the overconfident bears were several weeks ago.

Never forget the market moves in waves. It always has and it always will. After several weeks of nearly non-stop gains, it is normal and healthy for the market to slip back to support. But just like how this breakout isn’t racing to the moon, don’t fall for all the predictions the next few down days will lead to the next market crash.

There are so many exciting ideas I only briefly touched on in this post that I look forward to expanding on in future posts. No matter what the fundamentalists and technicians claim, market prices are driven by human psychology and understanding that is the first step in unlocking the market’s next move. Sign up for Free Email Alerts to be notified when my next piece is published.

Jani

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Oct 03

Is it finally safe to buy?

End of Day Analysis:

The S&P500 finished higher for the sixth consecutive day and fourteen out of the last seventeen. There was no real news driving this strength, instead we continue rallying on “no news is good news”.

August was a rough month for stocks as repeated selloffs threatened to break this market. North Korea, political gridlock, and hurricanes all weighed heavily on the market’s mood. The news didn’t get any better in September, but amazingly enough, the market stopped caring and prices firmed up. For those of us that were paying attention, this was a powerful signal life was still left in this rally.

I did my best to warn Bears in my September 7th free blog post, very creatively titled, “A warning for Bears”. In it I cautioned a market that refuses to go down will eventually go up. I also encouraged bears to cover their shorts while their losses were small. The market closed that day at 2,465. A few weeks later we find ourselves 70-points higher in what looks like a painful short-squeeze.

Figuring out what the market is going to do isn’t hard once you know what to look for. In this case a market refusing to go down on bad news. The problem is too many people arrived with a bearish bias. This rally was “too old” and had gone “too far, too fast” and “a pullback was long overdue”. Bearish headlines convinced them it was only a matter of time before they would be proven right.

Blinded by confidence, Bears failed to recognize the significance of this counterintuitive strength because they were too busy arguing how dumb the market was. Unfortunately that’s not how this game works. When the market disagrees with us, without a doubt we are the ones who are wrong and it is best to get out of the way before we get run over.

But that was then and this is now. What most readers want to know is what’s comes next. Given how many up-days we’ve had over the last three weeks, the bears might finally be partially right. We won’t see the widely predicted crash, but 70-points in three weeks is a big move for this slow-moving market. At the very least we should prepare for a normal and healthy pullback to support.

One-direction moves are often fueled by bears scrambling to cover their shorts. This creates a flurry of near-term buying, but short-sellers are a relatively small group and they don’t have the buying power to drive larger moves. After a certain level most bears have capitulated and then it is up to other buyers to keep a move going higher.

Only big money has the resources to keep a larger directional move going. But the thing to know about big money is it hates chasing prices higher. Most of them have been doing this long enough to know that if they are patient, the desperate buying will subside and they will be able to jump in at lower prices. In many ways this becomes a self-fulfilling prophecy because if enough traders wait for a pullback, the lack of buying actually causes the pullback.

Without a doubt the path of least resistance is higher, but we know markets don’t move in straight lines. We need to mix in a few down days to keep this market healthy and sustainable. When a red-day happens, don’t freak out and start calling a top. If this market was going to crash, it would have happened weeks ago when headlines and sentiment were far more dire. Instead, expect the rate of gains to slow and for the market to spend a few weeks consolidating recent gains. We can keep going up for a few more days, but the higher we go, the harder we fall during the normal and healthy down wave. But either way, this is definitely a better place to be taking profits than adding new positions. Buy-and-hold investors can keep holding, but traders with profits should start thinking about locking them in, and those with cash should resist the temptation to chase.

Jani

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Oct 01

Monthly Scorecard: Cracked.Market blog hits a grandslam in September

Welcome to Cracked.Market’s Monthly Scorecard:

This post includes a summary of last month’s market developments, links to several key blog posts, and critical analysis of the accuracy of each post.

Part 1: Monthly Analysis

September is historically the second worst month for stocks, just barely beating October’s abysmal performance. Unfortunately anyone who used that historical track record as an excuse to skip September missed an impressive surge to all-time highs. Who would have guessed using the rearview mirror to figure out where the market is headed is a bad idea?

All too often traders fall for these statistical anomalies, a bad habit often perpetuated by the financial medial that loves repeating these nearly useless facts. “Sell in May and go away”, “October is the worst month for stocks”, “This is the longest we’ve gone without a 3% pullback since 1928”, etcetera, etcetera, etcetera. These facts are little more than trivia and just as useless as knowing how many movies one actor was in with another actor. You can impress your friends with these facts, but they are of little practical value when it comes to timing trades.

No doubt there are quirks to the calendar that makes some of these statistical anomalies pop up, such as options expiration, end of quarters, and calendar years. But the thing to remember about these patterns is they are far weaker than current events and price-action.

This September’s price-action was dominated by a decisive rebound from August’s North Korean pullback. This relief rally was far more powerful than September’s traditional seasonal weakness. What happened yesterday, last week, and last month is always far more significant than what happened last year, last decade, and last century.

Looking ahead to October, the recent dip and churn in ownership created a strong foundation to build on. Volume returned in September as big money came back from vacation. Rather than lock-in profits, big money is more inclined to buy these highs. If this market was fragile and vulnerable, we would have plummeted weeks ago. This is a strong market and I expect it to only get stronger as underweight money managers give up waiting for a dip and start chasing prices higher into year-end.

In the next section I analyze all eight of my free blog posts from September.
How do you think I did? Tell me in the comments.

Click the title to read the full post.

Part 2: Scorecard

Tuesday September 5th:
Why this selloff is no different

[Is] the rebound really dead? Three things tell us not to be so hasty.

First the late-day rebound put us back above key support. The 50 day moving average was a ceiling for most of the last few weeks. But overhead resistance often turns into support after we break through. Today’s late recovery suggests that is the case here. Rather than spiral out of control, supply dried up when we tested this key support level.

Second, volume was one of the highest days we’ve seen in recent weeks. All the other sharp down-days also included elevated volume. But rather than portend of worse things to come, these high-volume days were capitulation and we rebounded within a day or two.

Third, all of these headlines are recycled. There is nothing new here. If one of these stories was going to take us down, it would have happened already. Selloffs are breathtakingly fast. Hesitate for a moment and it is too late. Sell first and ask questions later is the first rule of surviving a crash. But this North Korea selloff is going into its fourth week. The market never gives us this much time to think rationally and act calmly before a punishing selloff.

Score 10/10: September 5th’s weakness was the lowest point in all of September and we rebounded decisively for the remainder of the month. The 5th’s dip was nothing more than one last head fake before humiliating every reactive seller during its surge to record highs.

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Scorecard

Thursday September 7th:
A warning for Bears

For nearly a month this market has withstood one bearish headline after another. We slipped under the 50dma for a brief period. All of this selling cleared out most owners who could be convinced to sell. Now all that is left is people who don’t care about these headlines. No matter what people think “should” happen, when there is no one left to sell a headline, it stops mattering.

This is an important thing for bears and most especially shorts to understand. You have been given a golden gift in this relentless barrage of negative headlines. There has been more than enough to cripple a vulnerable market. But the thing to keep in mind is selloffs are breathtakingly quick. Sell first and ask questions later is the only way to survive a market crash. Yet here we stand nearly a month into this “selloff”. If we were going to crash, it would have happened by now. If this relentless barrage of headlines couldn’t scare owners into selling, I don’t know what it will take.

Anyone who is still short this market is probably only a little in the red. Rather than hope and pray for the selloff that isn’t happening, a smart trader admits defeat and takes his losses while they are small. This bearish trade has been given every opportunity to work, but this simply isn’t the right environment to be short. Be proactive and close a trade that isn’t working when the losses are small, rather than wait until the pain of losing money gets so strong it forces you out.

Score 10/10: What else is there to say? I told bears to close their shorts for a small loss before things got worse. I doubt many listened, but they had every opportunity to save themselves a big chunk of money. The key to surviving the market over the long haul is recognizing when you are wrong long before the pain of loss forces you out. Once you get good at this, some of my bad trades were actually closed for a profit because I recognized my mistake before prices turned against me.

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Scorecard

Tuesday September 12th:
Why bears got it wrong

There is no magic to this. Basic market psychology and supply and demand told us the path of least resistance was still higher. In early August we tumbled when Trump and North Korea fell into a war of words that quickly escalated into North Korean missile and nuclear bomb tests. Then the Trump administration endured a rash of turnover in its senior ranks and at the same time exchanged barbs with senior Republican leaders. And finally two hurricanes did their best to pummel the Gulf Coast. Any one of those things would have crushed a vulnerable market. Put them all together and it creates a storm only the strongest market could endure. Yet that is exactly what we did.

Score 10/10: A market that refuses to go down will eventually go up. The writing was on the wall all month long. I hope you saw it.

Scorecard

Thursday September 14th:
North Korea still doesn’t matter

But just as things were starting to look good, North Korea launched another missile over Japan after Thursday’s close. Fortunately the stock market is reacting less and less to each successive provocation. In after-hours trade the S&P500 only dipped 0.2%. That’s because stock owners who fear this story sold weeks ago. These nervous owners were replaced by confident dip-buyers who demonstrated a willingness to hold these headlines. If there is no one left to sell the news, it stops mattering.

Once we traverse this latest North Korean speed bump, expect the slow drift higher to continue. Confident owners don’t want to sell no matter what the headlines say and their conviction is keeping supply tight. Conventional wisdom warns us about complacent markets, but what it often forgets to mention is these periods of complacency last far longer than anyone expects.

Few things calm nerves like a rising market. Expect these steady gains to shift the focus from fear of a crash to being afraid of being left behind. Recent sellers and underweight money managers will start realizing the dip they predicted isn’t going to happen and they will be forced to start chasing prices higher. Last week’s seller will be next week’s buyer. And that’s how the slow grind higher will continue.

Score 10/10: Hopefully you are starting to see a trend develop here. Hindsight is 20/20 and this analysis seems obvious now. Luckily for those who were paying attention and knew what to look for, it was painfully obvious as it was happening too.

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Scorecard

Tuesday September 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 affected the market in a significant and lasting way. I don’t expect tomorrow to be any different.

Score 10/10: North Korea and the Fed couldn’t dent this rally, but readers of this blog already knew that.

Scorecard

Thursday September 21th:
Don’t fear a routine and healthy dip

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.

Score 10/10: A little dip after a long string of up-days was nothing more than catching our breath on our way higher.

Scorecard

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

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.

…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.

Score 10/10: September’s bearish looking fizzle turned out to be nothing, exactly as I expected. One of the most important things about trading is knowing what rules to use when, and when to ignore those rules.

Scorecard

Thursday September 28th:
The bull that refuses to die

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.

Score 10/10: The next day we surged to record highs and September ended on a strong note. If big money was going to take profits, we would have seen that selling show up in the price-action. Expect October to be another good month for stocks and keep buying the dips.

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

Jani

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Sep 29

Weekly Scorecard: Why this breakout was inevitable

The most powerful technique for analyzing the market

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.

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.

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.

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

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

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

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

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

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.

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

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