Weekly newsletter of Danny Merkel - Issue #97
Market Review:
This continues to be a tricky trading environment for Trend Following traders. Every asset class - not just stocks - is in a state of flux and is experiencing strong cross currents.
An important change in trend recently occurred in the US Dollar Index. After triggering a positive momentum change in June 2021 (dashed vertical line) a lovely uptrend unfurled, but that has now come to an end (red arrow).
US Dollar Index with short-term trend (20 & 50dma)
Now it may be tempting to get on board the short side and ride the greenback lower, but this is not something I’m interested in doing. The reason is that the long-term trend, although not shown, remains up.
This places the USD in the uninteresting zone of neutral, meaning I cannot buy it and cannot short it.
Meanwhile, all of this Dollar weakness is translating into strength in emerging market stocks. The iShares Emerging Market ETF had been in a non-stop downtrend for an entire year, but that has finally come to an end:
EEM with short-term trend (20 & 50dma)
Similarly, this isn’t a buy signal either due to the fact that the long-term trend remains down, so we have another asset class firmly in the neutral zone.
Moving on to stocks, the Russell 2000 continues to trade in an extremely erratic manner.
During chop-fests like this, trend following trading becomes difficult on all timeframes. To illustrate the choppiness of the market, I created what is known as a moving average ribbon, which is a type of chart that contains dozens of moving average combinations.
Referring to the right side of the chart, we can see that this year’s price action has created a complicated quagmire of intersecting lines:
At this moment, numerous short-term moving average pairs have crossed positively, which is a start; however all of the longer-term pairs have much more inertia and haven’t budged.
In contrast, compare today’s extreme entanglement to the smoothly flowing moving averages of December 2020. If you’re like me, you were raking in money back then, but can’t make a dime today.
That’s because the market regime today is completely different and the chart above helps to visualize this fact.
Commodities:
With the US Dollar under pressure, you might expect to see commodity prices breaking out, yet the exact opposite is happening.
For example, Crude Oil hit a 200-day-low this week. Even though I don’t personally trade this type of signal, longer-term Trend Followers (such as Jerry Parker) incorporate them into their trading system.
With this type of long-term trading, you’d enter Crude Oil back in December 2020 at a price of $50, ride it all the way up to $130 as the Ukraine War started, then ride it all the way back down, exiting at $80:
In some ways, you can feel how unsatisfying this trade ended up being.
-You should have bought sooner when the price was lower, at $35.
-Why didn’t you just sell when you had big profit at $130?
-What do you mean you rode it all the way back down?
One interesting quirk with human nature is that losses feel twice as bad as gains feel good.
So let’s you buy a stock at $100 and it goes to $150. That’s great, you feel, say, 50 units of happiness - you’re making money and you feel good - obviously.
But then the price of the stock slips back down to $125. Because losses feel twice as bad, you experience 50 units of pain, which cancel out the 50 units of happiness you just had.
So in this example, you bought at $100 and the stock’s currently at $125 - you have a 25% gain - yet you feel no happiness.
Likewise, the Crude Oil trade gets you in at $50 and you sell at $80. You actually do make a lot of money, but since you gave so much back, you’re still unhappy.
Trend Following makes money, but it tends to be unsatisfying emotionally.
Dividends Part II:
To briefly recap last week’s discussion on dividends, I mentioned that I never strive to earn dividends, but if I do happen to receive one, then that’s great.
But there exists a large group of retail traders who believe that buying prior to the ex-dividend date entitles them to receive a kind of free bonus.
Although I think there is no free lunch, the fact remains that if enough people pile in before a large dividend, it could create an updraft in price that could be ridden by the astute momentum trader.
This theory was put to the test by Nick Radge in his groundbreaking book, “Profiting From Dividend Momentum”.
Thanks to Amazon Affiliate links, I can see that nobody actually bought the book, so consider yourself lucky that I have summarized the entire strategy here: