Newsletter of Danny Merkel - Issue #138
Market Review:
Let’s begin with a few fast facts on the S&P 500.
Firstly, it’s always worth paying attention to gaps, since they tend to act as support or resistance later on.
That turned out to be the case with the gap up in June that later turned into support (black up arrow) and also the gap down in September that turned into resistance this week (black down arrow).
This week’s failure at gap resistance also puts in a lower high (LH), so we now have a pattern of lower highs and a lower low (LL).
Overall, this price action ends the short-term uptrend, but this is not a short signal. At a minimum, I require a new 52-week-low to initiate a short and the S&P 500 isn’t doing that.
While large cap stocks have been quite resilient, there are hundreds of smaller stocks that are, in fact, making new lows right now.
For months, I’ve been hypothesizing that small-caps could put in a vicious second wave lower.
Fast forward to today, and small-caps are actually starting to do that. Right now.
If you’re a typical long-only growth stock trader, you will probably see this as a negative development; but if you’ve adopted a Trend-Following mindset, you should see this as a positive.
That’s because Trend Followers are just as willing to go short as to go long, so if this second wave unfurls into a new bear market, it will present the open-minded trader with numerous profitable trades on the short side.
Individual Stocks:
Despite being called a “perma-bear”, I have actually tried to make bullish bets. The only problem is that every time I do, I lose money.
As an example, I gave Boeing the benefit of the doubt when it broke out from a lengthy consolidation to a new high.
I thought to myself, ‘if this is a new bull-market, then let’s see this breakout run’.
Yet, as expected in this profoundly brain-dead market, Boeing’s breakout failed disastrously.
The “new bull-market crowd” just got pounded repeatedly by bearish black candles.
Can anyone seriously look at the above chart and conclude that this is a healthy pullback?
Moving on, I also pointed out that breakouts are failing nearly 100% of the time and used XOM as an example to prove this point.
Since then, Exxon went on to print a 10th new high. And how did this breakout turn out?
How many failed breakouts will it take to convince the average IBD trader that this isn’t a healthy bull-market?
Next, I also previously mentioned that MCD was constantly being rejected as that stock tried to breakout into new 52-week-high territory (red arrows).
In my opinion, that was a warning sign since it showed that institutions were not getting on board or, even worse, using strength to unload their position.
And without the support of big, institutional money we can see that McDonalds has totally fallen apart.
The price action of most individual stocks has been atrocious and, in some ways, I think it’s easier to lose money in today’s market than even a full-fledged bear market, such as in 2008.
You see, in 2008, everybody could clearly observe that markets were collapsing and going into cash was the obvious defensive solution.
But today, you have 8 big-tech titans propping up the indexes, which creates the illusion that everything is fine.
With this bullish mirage in mind, you then get many traders seduced into buying growth stocks, which are not in a bull market, where they get burned.
Overall, my conclusion remains that breakout trading doesn’t have an edge under this current market environment and the more often you buy breakouts the more money you will lose.
Option Trading:
The fact that I’m a breakout trader, most people reading this are breakout traders, and the reality that breakout trading has stopped working is not a fantastic combination!
Going forward, these are the choices available:
Pretend that nothing has changed and continue losing money buying breakouts
Realize that this is not a new bull-market and patiently refrain from buying breakouts until the market environment changes
Develop a new strategy that works in the current market environment
Now the first option seems quite popular on Twitter. Buy breakouts, have them fail, sweep the loss under the rug and try another breakout. The issue I have with this approach is that I manage money for other people and so I actually can’t just sweep losses under the rug.
The second option is more sensible, but can be quite challenging for those addicted to trading, which I believe is an underreported problem. Another challenge is that market conditions could remain unfavourable for an extended period of time. What if the markets continue in a high volatility trading range for the next 10 years? It happening during the 1970s and could easily happen again.
Finally, the third option is what I’ve been devoting a great deal of time and effort into.