On Being “With” the Market

• Posted by Derek
• on September 15th, 2012

“Well, it is a bull market you know” Old Man Partridge

In my early trading years, my worst days were always the same. Market up 100, I spot a market leader that just went negative…what a dog, right? I’m sure a mentor would have pointed this out to me sooner, but lacking help I had to get steamrolled by +200 days to see how laggard can turn leader on a trend day. And while I’ve never flipped my natural urge to sell a weak stock in an up tape or buy a strong stock in a down tape, I’m now able to marry those opposing forces in a way that honors the micro while respecting the macro.

It’s easy to fix that error if you’re a day trader; just don’t fight a trend day no matter how weak an individual stock looks in the morning. How do we translate that lesson into a multi-day or multi-week position? In most cases, a simple look at the past few weeks on a 26-78 minute(or 65) chart on $SPX or $RUT can do it. That covers 75% of the sentiment swings, most of which are obvious by simply knowing whether our P/L has been getting better or worse of late(not to be confused with “Have I been getting smarter or dumber of late?”). What about the 25% of the time when the answer is not so obvious? It took me years to put that answer into a framework that I could execute…I wish someone had saved me a few thousand hours so I’ll try to do that here. We all speak “weather”; I’ll try using it as a language to convey my point.

When planning an outdoor event, do we start by checking the forecast? Kind of, but before getting to that point we’ve subconsciously considered a) a map and b) a calendar. No matter the radiance of the sunshine or clarity of the 7 day forecast, as a kid in Western New York I knew that golf in December was not an option. Or later, that a sunny July afternoon in South Florida was not a license to leave the umbrella at home. These things are obvious when stated, but would they be obvious without having a full grasp of our local climate? Looking at a single chart without grasping the market’s “season” is the trading equivalent; it can work, but we save ourselves a ton of frustrations by understanding the overall context.

Here is a section of the map and calendar I use to gauge the market climate:

 I track around 400 big, liquid, active U.S. stocks(non utilities and REITs) and feed them into various layouts. I then take the temperature of these stocks a few different ways, and at a few key times of the day, to measure the evolving flow of funds. I’m not sure what Art Cashin is doing when he jots down notes on his notepad, but this is my version of the same…it’s like constantly reading 400 multiple time frame charts with a predefined lens. What % of stocks are thrusting higher? Is it more than the last time I checked? More than yesterday? Last week? vs. a recent day when $SPX was at this level? Is that number accelerating when I check shorter periods vs. longer periods? If not, is it completely stable at such a high(or low) level that acceleration is not necessary to continue the trend? This is what I do, track these numbers all day and use the verdict as the primary determinant of how quickly I should act on a new long idea. Or a possible breakdown of an existing long. Or whether I should size up or size down the next idea.

We may get incrementally smarter over the years in developing our trading blueprints, or better at executing those plans. Assuming a consistently applied set of methods, what we don’t do is get hot and cold; the market dictates those swings. Sometimes it’s just easier, sometimes it’s harder. Sometimes economic conditions get so stormy that the marginal company gets wiped out; sometimes the storm recedes just in time for the terminal company to survive. Our hot streaks are simply periods when our method lines up with a supportive market, and cold streaks are when they clash. I could toss aside every piece of evidence I use if you just told me one thing…is the market’s wind at my back, or in my face? Funny how much smarter my buys get when institutions are spending funds rather than pulling them out.

Essentially, what my climate map does is provide a breadth-based exit(and entry) system to support or resist ideas I’m considering on a micro level. When the climate is good, I give extra time before acting on sell stops but am vigilant with buy stops(and vice versa). We know intuitively that in a bullish climate many sales prove to be mistakes; I liked a recent tweet from Jeffrey Carter to the effect of “a market is bullish when you get multiple chances to “fix” your bad buys”. Taking note of our map and calendar is a wonderful way to turn the urgency of exit and entry up or down a notch. The ultimate momentum indicator, for my needs at least.

In recent years I’ve gained so much insight on collecting evidence from guys like @alphatrends and @daytrend (among others) who so generously share their work. I think the best way for me to pay for my consumption is to share when changes occur in my climate measures. I know from experience that writing a narrative every time is an obstacle to sharing it in a timely fashion…when the shifts occur, I’m busy shifting with it and not interested in describing the details. So I’m writing the backdrop now, and will share a simple picture and a few words when the evidence shifts. It’s going to take me another post or two to convey my decision tree, so chime in with a comment on areas that need clearer explanation.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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