Newsletter of Danny Merkel - Issue #114
Hello. Okay, let’s proceed with the analysis of the market.
The chart below displays the S&P 500 and starting with the right-hand-side a new development is the formation of a higher-low:
A higher-low is a good start for the bulls and a major improvement over the series of lower-lows the index formed all throughout the previous year.
Next, the blue channel illustrates the 52-week-high and 52-week-low zones. At this moment, the S&P 500 is approximately in the middle, near the dashed mid-point line.
For Trend Following traders, new 52-week-highs are bullish and new 52-week-lows are bearish. Because the index is sandwiched in the middle, I think it makes sense to be neutral.
To be more precise, since the market has slightly surpassed the mid-point, you can do some easy math and say that I’m 54% bullish and 46% bearish.
I can imagine if a pundit went on CNBC and proclaimed that he was 54% bullish, he’d probably get no airtime. When it comes to predictions, go big or go home. If you think Bitcoin is going to a million, or if you think the market is going to crash 80%, then those are the forecasts that get airtime. Nobody cares about a nuanced view.
Anyway, here’s something perhaps more interesting. If I’m roughly neutral on the market and if I turned the chart up-side-down then, logically, I should still be neutral. Let’s try that.
When glancing at the inverted chart above, my view stays the same. There’s nothing special about the chart that causes me to be particularly bullish or bearish. It’s been a choppy trading range all year. Nothing more.
This up-side-down chart trick is something I try with those new to the game to gauge their potential to be full-time traders.
Here’s a neat example from the past that shows what I mean:
You can invert any chart in StockCharts by simply adding a minus sign in front of the symbol. I think it’s a useful tool.
Moving on, as the S&P 500 rose 3.51% for the month of March a curious fact is also true: the average stock within the index actually fell about 1 percent.
The equal weighted version of the index, as measured by the fund RSP, fell for the month. This means that the market was kept afloat by a handful of mega-cap names, such as NVDA.
If you go beyond the S&P 500 and look at every other liquid stock in America, you end up with this chart:
Trading under the symbol VXF, this fund tracks 3,691 stocks - everything except the S&P 500.
Under the hood, the picture is not as rosy. The average stock in America fell for the month and remains in a long-term downtrend.
So what does this all mean? From a Trend Following point of view, if the market is rising due to Nvidia rising, then go ahead and buy NVDA if that meets your rules.
The big mistake I can see less experienced traders making, though, is they see the market rising and feel like they’re missing out (FOMO), and then start loading up their portfolio with stocks that have no correlation to the market.
Option Trading:
Given that I’m 54% bullish, the most optimistic view possible would be to call this a “weak bull-market”.
In a weak bull-market, aggressive momentum trading doesn’t work well.
For example, the stock IOT gapped up to a new all-time-high on massive volume. Is this bullish?
In a strong bull-market, this would have been bullish. If this was 1988, 1995, 1999, or 2013 then chances are this breakout would have kept on going.
But in today’s half-alive half-dead market, the breakout naturally sputtered out.
So the question is, what works well in a weak bull-market?
A trader, whether he realizes it or not, has the following choices:
Buy the stock
Short the stock
Buy a call
Buy a put
Write a call
Write a put
A combination of the above
Do nothing