What Are We Fading?

  • Posted by
  • on August 5th, 2011

Other than the select few who have been smart enough to get short and disciplined enough to stay short, most of us have been fixated on waiting out a buying opportunity.  Despite an abundance of evidence suggesting unrelenting downward momentum, I myself have taken calculated shots at snatching a snack from the alligator’s mouth.  Before Tuesday’s break of the June lows, I bought $SSO amidst a “panic” and was swiftly taught not to try again…risk management saved me from my stupidity.  After Wednesday’s reversal from the lows, I felt that if I could find a basing stock I’d make another long attempt into the Thursday AM weakness.  Out of 400 stocks, I found one…I bought $SBAC, and again was swiftly saved by risk management as Wednesday’s lows were taken out before lunch.  The fact that I dug hard to find 1 confirms what I already know; stick to macro when things are this extreme.

Why am I not short?  Take a quick look at the following evidence as of Thursday night:

I can’t be short here.  I have tremendous respect for trends, and am fine with winning 1/3 to 1/2 of the time as long as my wins are much larger than my losses.  But the thought of accepting a 5-10% win rate in hopes of a crash doesn’t jive with my psyche…just as seeing 99% of stocks up would have me missing the end of a bull stampede.  Doesn’t mean it’s right, just means my belief in trends has boundaries based on risk and reward.  More important than ANY strategy is the will to follow it free of doubt.  Markets offer us so many winning opportunities that we simply need to avoid forced trades that can damage that will.

I bought a September $VXX put spread on Thursday’s close; I’m fine with it.  Price may continue lower in coming days, but this is a trade measured in weeks, not days, and most importantly my risk is defined.  I’m willing to scale in larger if yesterday’s panic is not the panic, still to a point where my equity is dinged no more than 1.5%.  The % of stocks above their 10 Day Moving Average WILL cycle back from 1% to somewhere north of 50% at some point in the coming weeks.  $SPY may be lower at that time and $VIX higher, but will provide an actionable sell to exit my buy.  Not for everyone, and not with trend, but I was a trader before I ever understood trends and some trades just need to be taken.

There are so many more aggressive ways to fade this 10% selloff, but I don’t like any of them.  Price troughs/peaks after momentum, and I don’t have the slightest evidence that even momentum has peaked despite the short-term extremes that we all see.  A defined risk fade on a mean-reverting vehicle that has shown itself to have built-in decay may not work, but it’s a trade I prefer to any other type of knife catching.  The problem with buying price here is that any support levels I draw are from months ago; they act as guidelines for me to think 1175-1250 is a likely $SPX range but there is zero recent price memory here so I have nothing upon which to lean.

If markets are going to recover, there will be a better day to follow price.  We will have seen a 500 point bounce from the lows that gets sold, then volatile trade that wears everyone out.  In the meantime, a growing % of stocks will have shifted from downtrends into ranges yet the indices will seem stagnant.  THAT will be the time to buy.  Brian Shannon will tell you stocks are respecting a rising 5 day average.  Joe Fahmy will tell you $XYZ has setup and is now breaking out.  Joe Donohue will be killing it on big swingers that seem too high to buy against the crummy news backdrop.  At that time, fund managers will regret not having bought lower and be the source of buying.  My goal is to be in the moment when those days arrive.

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.

blog comments powered by Disqus
Derek Hernquest Blog