Restraint

  • Posted by
  • on February 4th, 2012

Everyone knows the following:

1) Stocks are in a raging uptrend showing no signs of letup

2) They’ve travelled a long way in a short time and are entitled to a break

As traders, we constantly walk a tightrope between identifying an emerging opportunity and recognizing when it’s too obvious. I’ve learned through many mistakes that obvious doesn’t mean sell(or cover); for me, it just means find something else to buy or short. Is there a way outside of the fuzzy sentiment polls to measure “obviousness”?

Keep in mind that the market is made up of intraday, swing, and position traders, and also covers the spectrum from mean reverters to trend followers. The successful traders I’ve seen lean heavily to one side or the other but acknowledge that the other side has the power to steamroll their best idea at any moment. Having relied on “gut feel” for years, I needed ways to quantify “obviousness” to prevent me from giving myself(or the other side) too much credit. I read the polls but more for entertainment than anything; the best real-time sentiment indicator is price itself.

One such measure I apply across my universe is “Change in ATR over X periods”, which I track on a 6-8 day basis, 5-7 week basis, and 5-7 month basis as I find that’s the time needed to turn doubters into believers in their respective timeframes. As I’m plowing through charts looking for trends, this is a simple and objective way for me to make sure I’m not chasing someone’s expiring idea. I’ll highlight the weekly one today because it’s the one that just went “obvious” on Friday. Take a look at the following chart of $SPX:

This is no super-secret indicator here screaming “SELL!!”. It’s simply a reminder to me that someone out there has 4 Weekly ATR worth of $SPX profit in 7 weeks, and it might take only the slightest selling to shake that position loose. I already know that intuitively, but applying this ATR measure to all candidates lets me see where I sit relative to the smarter folks that got there before the trend had emerged. I can stay in the moment without losing perspective of where this moment sits amongst a series of moments.

Friday’s readings across a host of ETFs tells me what I already know but states it more objectively…we’ve reached levels of obviousness that have historically rewarded those who can restrain themselves for a few days(weeks?). The guy who hangs out the car window telling everyone how much money he is making might be about due to for the “face hits mailbox” moment; my job is to remember that I’m no less ignorant than I was a month ago.

Conditions may have changed, but they’ll change again. I’ll continue buying emerging candidates, but never without considering as Brian often says “where have they come from?” Right now, the trends in $XLE, $FXI, & $EFA to name a few, look to have every bit as much fresh strength as other areas but haven’t moved quite as much. Perhaps a few sideways/down days will allow those to set up as solid reward:risk candidates for the next move. Either way, my seat belt light for U.S. indices just came on and that means I need to consider the potential for a correction in time or price.

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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