Written by Jeff Miller, A Dash of Insight
— this post authored by Mark D. Hines
Our previous Stock Exchange asked the question: Is Breaking News Useless Noise Or Trading Fuel? We reviewed several popular narratives for the sell-off that accelerated recently, and then recommended that traders and investors be careful to focus on the right kind of data. And even though the selloff has reversed somewhat, the topic remains very relevant.
This Week: Do You Pretend to Understand The Market?
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Volatility has spiked and the market has sold-off, as shown in the following chart.
And it seems there is never a shortage of explanations when the market sells-off. For example, common themes this time around include spiking interest rates, the China trade dispute, and the notion that we were simply “due” for a sell-off. A recent Bloomberg article (Everybody Pretends to Understand the Market) offers some levity on these types of narratives. For instance:
Everybody has answers that are seemingly obvious now… but if these were so obvious, then why did nobody see the collapse coming?
The article goes on to explain that there are some obvious forces pushing markets around (for example, the market is driven less by fed stimulus and more by fundamentals than it was 5 to 7 years ago). And that this is:
…a healthy development in the long run, but often no fun in the short run, as we’re seeing lately.
And from a psychological standpoint, Dr. Brett Steenbarger offers outstanding perspective (as usual) in his post: What Happens After A Huge Down Day? Specifically, he reviews data from similar historical sell-offs, and concludes with this:
…my takeaway is that investors should have a long-term view of opportunity – on a long time frame these were good buying opportunities – but on a short time frame a degree of hedging is prudent. Shorter-term traders should view a failure to sustain bounces as possible occasions for further large declines. Open-mindedness is key.
In our specific trading examples later in this report, we review a couple different dip-buying opportunities, as well as examples where caution is prudent. But first, here is a look at our recent trading model performance:
Model Performance:
We are sharing the performance of our proprietary trading models, as our readers have requested, as shown in the following table:
We find that blending a trend-following / momentum model (Athena) with a mean-reversion / dip-buying model (Holmes) provides two strategies, effective in their own right, that are not correlated with each other or with the overall market. By combining the two, we can get more diversity, lower risk, and a smoother string of returns.
For more information about our trading models (and their specific trading processes), click through at the bottom of this post for more information. Also, readers are invited to write to main at newarc dot com for our free, brief description of how we created the Stock Exchange models.
Expert Picks From The Models:
This week’s Technical Thoughts is being edited by guest contributor, Blue Harbinger (Blue Harbinger is a source for independent investment ideas).
Holmes: This week I bought Lululemon Athletica (LULU). They specialize in athletic wear for female youth. I bought on the Wednesday dip. What do you think about that trade?
Blue Harbinger: Interesting trade. Personally, I like to buy the dips too, but only after I have completed my detailed fundamental long-term analysis. The dip on this one looks compelling, but I am only moderately familiar with LULU. Here is a look at some of the fundamental data in this Fast Graph.
Holmes: I appreciate that you’re into long-term fundamental data, but I am a technical trader, and my typical holding period is around 6-weeks. I am often in and then out of a trade in less time than it takes you to do all that fundamental analysis you like.
Blue Harbinger: Well if you like this business, the setup looks good too.
Holmes: Gee thanks, Blue, but I like the technical set-up, not the necessarily the business. Anyway, how about you Road Runner – any trades to share with us this week?
Road Runner: You bet. This week I bought Electronic Arts (EA). As you know, I like to buy stocks in the lower end of a rising channel, and the setup on EA is highly compelling.
BH: I supposed buying in the lower end of a rising channel is another form of dip-buying. Although this week’s dip is more market-wide than EA specific. Don’t you think?
RR: I am a computer model. I think much more logically and objectively than you. I am well aware of the market wide sell-off, and I am comfortable with this trade.
BH: Well aren’t you nervous there is another shoe to drop?
RR: Again, I am a computer – I don’t have emotions. However, I do make adjustments for varying degrees of market volatility.
BH: Based on the above chart, EA has certainly been volatile. I know your process is based on technical indicators, but here is some fundamental data for you to consider:
RR: Thanks for the data. However, my typical holding period is typically only 4-week. I move faster than quarterly earnings updates.
BH: Ok then. How about you, Athena – any trades to share?
Athena: I bought some California Resource Corp (CRC) last week on 10/5. I too am a momentum trader, and my typical holding period is around 17 weeks.
BH: This is the E&P company that spun out of Occidental Petroleum. I believe they serve California exclusively. Here is a look at the Fast Graph.
Athena: Thanks for that information. Check back with me in about 17-weeks – this one is likely going higher from here.
BH: Great – will do. And how about you, Felix – what have you got to share with us this week?
Felix: For starters, I sold my Akorn Pharmaceutical (AKRX) shares recently, after having bought them near the end of August. This trade didn’t work out. I sold them at a loss, but given the heightened volatility, sometimes its good to cut your losses before they get to big. You can’t win them all, but as long as you make more on you winners than you lose on your losers – you’ll be in good shape.
BH: Sounds like sage advice. Do you have anything else you want to share with us this week?
Felix: Yes – this week I ran the Russell 2000 (Small Cap) stocks through my model, and my top 20 rankings are included in the following list.
BH: Thanks for that data, but would you mind reminding us – what is your trading strategy?
Felix: I am a momentum trader, and my typical holding period is 66-weeks (considerably longer than the other traders).
BH: Your longer holding period is interesting. Thanks for sharing your ideas.
Oscar: This week I rank the High Liquidity ETFs (with Price*volume over 100 million) through my model, and my top 20 rankings are included in the following list.
BH: I see you like oil (USO). That could be an intelligent trade if inflation rises faster than the market is expecting. Thanks for sharing.
Conclusion
Hindsight always seems 20/20, but one way to judge someone’s claims is to review what they were saying and doing right before the market sell-off. Alternatively, you might proactively set up an investment and trading strategy to meet your individual needs, so when the market does sell-off – you’ll be prepared and ready. And of course, beware of pundits bringing post-sell-off explanations – they’re often just pretending to understand the market.
Background On The Stock Exchange
Each week, Felix and Oscar host a poker game for some of their friends. Since they are all traders, they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check out Background on the Stock Exchange for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present and the only one using any fundamental analysis.
The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.
Getting Updates:
Readers are welcome to suggest individual stocks and/or ETFs to be added to our model lists. We keep a running list of all securities our readers recommend, and we share the results within this weekly “Stock Exchange” series when feasible. Send your ideas to “etf at newarc dot com.” Also, we will share additional information about the models, including test data, with those interested in investing. Suggestions and comments about this weekly “Stock Exchange” report are welcome.
Trade Alongside Jeff Miller: Learn More.
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