What I’m Observing in Stock Indices

Right Now:

DJIA: At an all-time high

S&P500: At an all-time high

NASDAQ 100: Just below the all time highs of 2000 and late-2015

RUSSELL 2000: Just below the all time high of mid-2015   

I believe that the probability of stocks continuing to move higher increases if the NASDAQ 100 and Russell 2000 break past their all-time highs. The technical move in stocks is ‘confirmed’ if all the major indices surpass their all-time highs.

This also means that if the NASDAQ 100 and Russell 2000 can’t push through their highs, it will be difficult for stocks to keep this recent move going.

Historically:

Markets become increasingly susceptible to bubbles when interest rates are low and money supply is high. This is the environment we are currently in. Historically and intuitively, we are in for an eventual big correction in stocks due to monetary policy. But as long as interest rates hug 0%, we could be in for higher prices in stocks for some time. There is no saying where the top is.

 

My preference is to follow what the aggregate voice of the marketplace is telling me. My core strategy is to buy strength and sell weakness. This puts me in position to capture the big moves in markets. While I acknowledge the fundamentals of stocks, I’m not one for calling tops and bottoms. I’ll let the market do that for me.

 

Anytime I think that interest rates will stay at 0% forever, and that prices are going to the moon, I’ll come back to this quote:

"But I think our ace in the hole is that governments usually screw things up and don't maintain their sound money and policy coordination. And about the time we're ready to give up on what has worked, and proclaim that the world has now changed, the governments help us out by creating unwise policy that helps produce dislocations and trends."

-Jerry Parker

Crude and Stocks

The correlation between stocks and Crude Oil has been strong.

I think the correlation may be due to bank exposure to oil debt--The lower oil goes, the greater the probability of oil companies defaulting on their debt.    

While stocks have been moving higher lately, oil has moved lower. I think this price divergence is worth noting.  

There is no saying where oil goes from here, but if the prices continue to move lower, stocks may follow.   

Based on recent price data, I have a hard time believing in a reality where oil moves back down to $40 and stock indices stay strong. But, then again, anything can happen in markets.

Post-Brexit

Last week I posted a chart of the DJIA post-“Brexit.” Here’s where the DJIA was:

Here’s where the DJIA is now:

This was one of the wildest weeks I’ve ever seen in the market. I could not have imagined the DJIA could move so fast in both directions in only five trading days. The “V” move up from 17000 was remarkable.

If the DJIA fails to break above 18,000 in the next few weeks, I expect the stock market to move erratically in the search for price discovery and thus for volatility to increase.

With increased volatility comes more expensive option premiums.  

You can’t buy insurance when the house is already on fire.

--

When the VIX, the CBOE volatility index, spiked up last Monday, gold and silver surged higher, as did the $USD in relation to the falling British Pound and global stock markets.  

The big moves up in gold and silver are telling in relation to the current market environment. Gold and silver continued their move upward as the $USD and the VIX dramatically fell while the stock indices recovered throughout last week.

Either gold and silver are foreshadowing more future volatility, or gold and silver are set for a big move lower.

Both scenarios are realistic, but in light of inflated currencies worldwide courtesy of low interest rates+QE, and a plummeting British Pound, its seems prudent to bet on volatility catching up to gold and silver’s price action, not the metals moving down.

***It's impossible to know if any of these trends will continue, but building low-risk, high-reward trading ideas around a general thesis with confirming price movements is an approach I subscribe to.  

Brexit Aftermath

I don't try to predict what markets will do. I live in the world of risk/reward paradigm.

I follow markets and place bets when I see favorable situations. To me, a favorable situation is one where I can bet a little and make a lot.   

It's not really the market ‘set-ups’ that make me money. The main driver is the respect for risk--which, in the long run, creates a market edge when applied to the ‘set-ups.’

Regardless of what direction I’m betting on, my market positions will reflect an aversion for large losses and an optimistic outlook on large returns.   

In my observation, the main stock market indices(DJIA, S&P500, NASDAQ) are moving to the downside.

From a technical view, there is essentially nothing stopping the DJIA from revisiting the August and January lows. There is a potential price vacuum from DJIA 17,000 to 16,000--I believe it's the path of least resistance.

And this 1000-point move can happen in short order.  

This is the main opportunity--DJIA 1000 points to the downside.

But this opportunity alone is useless if I can’t get a good ‘set-up’ and a good deal playing it.

If I’m wrong, and the DJIA shoots right back to 18,000, I don't want to lose much.   

I don’t like to bet directly on the indices.

I like to use the them as a weathervane. Once I have a general idea of the direction I want to bet on, I identify sectors that I believe are headed lower. Within the sectors, I’ll select the individual stocks that present the very best opportunity.

In this situation, I want to exploit a market downside by buying out-of-the-money puts. Namely on stocks that are currently moving in a downward direction, have trading volume of 1,000,000+(liquidity), and provide a disproportionately favorable risk/reward paradigm(cheap contract prices relative to a stock’s potential price discovery).

I will likely be wrong on most of my trades. But I want the potential to get 10X, 20X, and 30X my money on some of my trades. Simultaneously, I want to keep my exposure to the market small relative to my assets in my portfolio.   

The options market is tough. It took me a few years to really get the basics. You can only learn by doing--no amount of explanation will truly prepare you.  

There is opportunity for those who know where to look and how to respect risk. 30-to-1 payouts exist in markets. These payouts go to those who are prepared for them. If you do not believe that you can capture wins of this magnitude, your market decision will reflect that belief, and the right habits will never develop. In this sense, we all create our own destiny in markets.   

Trading in markets is a personal journey. But once the foundation is formed, you can take ideas from everywhere and process them through your system.   

Brexit Aftermath

I don't try to predict what markets will do. I live in the world of risk/reward paradigm.

I follow markets and place bets when I see favorable situations. To me, a favorable situation is one where I can bet a little and make a lot.   

It's not really the market ‘set-ups’ that make me money. The main driver is the respect for risk--which, in the long run, creates a market edge when applied to the ‘set-ups.’

Regardless of what direction I’m betting on, my market positions will reflect an aversion for large losses and an optimistic outlook on large returns.   

In my observation, the main stock market indices(DJIA, S&P500, NASDAQ) are moving to the downside.

From a technical view, there is essentially nothing stopping the DJIA from revisiting the August and January lows. There is a potential price vacuum from DJIA 17,000 to 16,000--I believe it's the path of least resistance.

And this 1000-point move can happen in short order.  

This is the main opportunity--DJIA 1000 points to the downside.

But this opportunity alone is useless if I can’t get a good ‘set-up’ and a good deal playing it.

If I’m wrong, and the DJIA shoots right back to 18,000, I don't want to lose much.   

I don’t like to bet directly on the indices.

I like to use the them as a weathervane. Once I have a general idea of the direction I want to bet on, I identify sectors that I believe are headed lower. Within the sectors, I’ll select the individual stocks that present the very best opportunity.

In this situation, I want to exploit a market downside by buying out-of-the-money puts. Namely on stocks that are currently moving in a downward direction, have trading volume of 1,000,000+(liquidity), and provide a disproportionately favorable risk/reward paradigm(cheap contract prices relative to a stock’s potential price discovery).

I will likely be wrong on most of my trades. But I want the potential to get 10X, 20X, and 30X my money on some of my trades. Simultaneously, I want to keep my exposure to the market small relative to my assets in my portfolio.   

The options market is tough. It took me a few years to really get the basics. You can only learn by doing--no amount of explanation will truly prepare you.  

There is opportunity for those who know where to look and how to respect risk. 30-to-1 payouts exist in markets. These payouts go to those who are prepared for them. If you do not believe that you can capture wins of this magnitude, your market decision will reflect that belief, and the right habits will never develop. In this sense, we all create our own destiny in markets.   

Trading in markets is a personal journey. But once the foundation is formed, you can take ideas from everywhere and process them through your system.   

Ray Dalio and The Economic Machine

Below is a link to an animated YouTube video of Ray Dalio explaining his belief about markets. The guy is worth about $15 Billion and he runs a $150 Billion hedge fund. He seems to be generous with his thoughts as the video is super informative.

How the Economic Machine Works

Fear of the Markets

In Jack Schwager’s Market Wizards, a common theme amongst traders is a genuine fear of the markets. I’ve chosen two quotes from the book that I believe best exemplify how market fear fuels trading philosophy.

1: “I am more scared now than I was at any point since I began trading, because I recognize how ephemeral success can be in this business. I know that to be successful, I have to be frightened. My biggest hits have always come after I have had a great period and start to think that I knew something.”

-Paul Tudor Jones

2: “I have found that the greatest traders are the ones who are most afraid of the markets. My fear of the markets has forced me to hone my timing with great precision. When I am trading properly, it is like a pool player running racks. If my gut feel of market conditions is not right, I don’t trade. My timing is a combination of experience and my nervous system. If my nervous system tells me to get out of the position, it is because the market action triggers something in my knowledge and experience that I have seen before.

I also don’t lose much on my trades, because I wait for the exact right moment. Most people will not wait for the environment to tip itself off. They will walk into the forest when it is still dark, while I wait until it gets light. Although the cheetah is the fastest animal in the world and can catch any animal on the plains, it will wait until it is absolutely sure it can catch its prey. It may hide in the bush for a week, waiting for just the right moment. It will wait for a baby antelope, and not just any baby antelope, but preferably one that is also sick or lame. Only then, when there is no chance it can lose its prey, does it attack. That, to me, is the epitome of professional trading.”

-Mark Weinstein