Coaches Corner:
Finding the Edge

As I was struggling to think of what to write about for this month’s edition of Coaches Corner, I finally decided, “Hey, why not just talk about our current market situation?”
First of all, I never want to trade just to trade. I always need to make sure that I have an edge. Trading without an edge is gambling, period! For me that edge comes from finding out what the institutional traders are doing and jumping on board. I don’t want to trade against them, I want to trade with them. They are responsible for the vast majority of the market volume and therefore the market direction.

I liken trading against the trend of the market to standing in front of a moving freight train and thinking that it’s going to turn around for you. Most likely you’re going to be squashed like a bug!

Fortunately, deciphering their sentiment is fairly easy to do given that institutional traders leave track marks when they trade. We can see this in a couple of different ways:
1) Follow the accumulation/distribution rankings in IBD.
2) Observing the trend of the market.

The market can only move thee ways – up, down or sideways. When the institutional traders are accumulating, the market rises. When the institutional traders are distributing, the market falls. So I can be bullish, bearish or neutral.

It’s important to remember that three out of four stocks move the direction of the market and it’s safe to say that closer to 100 percent are heavily influenced by the prevailing market cycle. Moreover, when the market is trending up or down it is easier to trade than when it is not trending.

So, where’s my edge if we’re not trending? Whose coattails do I ride – the bulls or the bears? I first need to figure out which way we are heading. Since most stocks trade with the market, the single biggest thing I can do to tilt the odds in my favor is trade with the market and not against it.

Historically, the November through April time frame is the best time to trade. As a matter of fact, according to the “Stock Trader’s Almanac,” over the past 60 years the Dow Jones Industrial Average has made all of its gains between November 1st and April 30th. According to the Almanac, a $10,000 investment in 1950 compounded to $527,388 for the intervening November through April periods compared with a $474 loss for the corresponding May to October periods.

The activity during the month of January is something else I’ll be monitoring. Why? “The Stock Trader’s Almanac’s” flagship indicator, the January Barometer (created by Yale Hirsch in 1972) states that as the S&P goes in January, so goes the year.

The January Barometer came into effect in 1934 after the 20th Amendment moved the date that new Congresses convene to the first week of January, with the Presidential inaugurations moved to January 20th. The long-term record for the barometer has been fantastic, sporting an 88.7 percent accuracy rate, with only seven major errors in 62 years. However, in the 62 years since 1950, only two of those errors occurred when the S&P 500 was positive in January, equating to an incredible 95 percent accuracy rate!

So what’s happening in the market right now? At the time of this writing IBD’s accumulation/distribution rankings have us at C- on the NASDAQ, which is neutral to slightly distribution-biased, while the S&P 500 is ranked B-, equating to a neutral to slightly accumulation-bias. It seems to me this averages out to neutral.

A quick look at the S&P chart shows neither higher lows/highs nor lower lows/highs, which would indicate we’re trendless. So I see us on hold, given that the market’s not giving us a strong bullish or bearish bias and neither side is tipping their hand for now. With such a backdrop, do I want to be doing many intermediate to long-term trades right now? No, I don’t have an edge until the market tips its hand.

That said, obviously the fiscal cliff situation puts us in a unique situation. If and when the market turns down, I do want to take advantage of that. I’m following Jeff and Karson to do this; and I’m also watching for the market to show me it’s going down. In the meantime I’m hedging myself with some trades on VXX and SDS. If the market starts trending higher than I will want to take advantage of that, likely with some money press and MIT-type trades.

Now it’s worth noting here that despite the lack of clarity, even in choppy, uncertain market conditions there are opportunities. On an individual basis there are always stocks that undergo sudden heavy accumulation or distribution phases. How do we determine this? They show us. When a stock rises on heavy volume, it’s under accumulation. When it falls on heavy volume, it’s under distribution.

I’m constantly on the lookout for any stocks making sudden strong moves. I’m particularly interested when a stock moves to a new high or new low, either by way of a gap or a breakout. These sudden moves show the stock being accumulated or distributed by the institutions. When this happens I can jump on board, even if it’s just for a very short-term trade based on this quick momentum.

How these situations play out over the longer-term is often influenced by market conditions. Since I don’t have a sense for that right now, I’ll just have to take advantage of the short-term. This can be day or swing-trading. A day trade means you’re in and out of the trade within the trading day; I’m not holding the position overnight. A swing trade means typically anywhere from a day to a week or so. I consider an intermediate-term trade to be anywhere from a couple of weeks to a few months.

Whether day, swing or intermediate, I still want to have an overall market bias and try to trade the majority of my positions accordingly. Even though we don’t have an intermediate-term bias, I can often build a short-term bias by simply evaluating our shot-term momentum.

Previously I wrote about implementing various strategies and the importance of matching the correct strategy to the direction of the stock. I frequently like to utilize spreads as a way of reducing risk when I place one of these trades. For short-term swing trades of this nature I can sell a call spread if I’m bearish or sell a put spread if I’m bullish. This gives me a higher probability of success. I just have to make sure that I keep my risk in proper alignment and I’ve found that stops are critical in these trades.

Bottom line, when the market is trending I like to take advantage of that trend, typically using intermediate-term strategies. When the market is choppy and not giving me a directional bias, I do shorter-term day to swing trades and get in and out. That way I can capture short-term momentum without being exposed to the market over a longer period when I don’t have a directional bias.

Hope this helps a bit… And remember, only trade when you have an edge – never trade just to trade!

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