Traders Edge Blog

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!

Musings from the Editor:
No More Dog Being Shakin by the Tail…

Well, the fiscal cliff came…and went…and in typical Washingtonian fashion, remains still ahead of us for the most part.

Yup – true to form and as was largely expected, the leaders in DC kicked the can down the road a bit. Not far, mind you – just a couple months.

As unbelievable as it would seem, and it surely defies logic, the “entire” den of thieves (aka POTUS and Congress) managed to pick the pockets of their constituents via new taxes (including an increase in the payroll tax that most directly hits the middle class – the very peeps the POLS are working hard to serve…supposedly), throw their largest corporate contributors some juicy bones, spit in the eye of small biz (yet again), place full blame on the “other side”…and most impressive of all – avoid imposing spending cuts…or for that matter, limits of any sort on themselves. In fact, while a raise for VP Biden and members of Congress was discussed, the only thing they failed to address at all was the issue of spending. But they are gonna get back to the issue….soon! Riiiiiggggghhhhtttttt.

Wow, can’t really make this stuff up…

Given that backdrop, you’d think we’d remain stuck in the mire and very much still held hostage to the machinations out of the beltway…for some time to come.
Well, YES…and… NO! Twisted, I know…but give me a moment and I’ll make the case.

Yes, we are still stuck, and the situation is bad and sure to get worse. The media will continue to feed on this and the POLS will continue to fling arrows and grandstand on the entire situation. And we will become even more fatigued with the process. Get ready for Debt Ceiling Borrowing Limit Part Deux…

More importantly, we’ll continue to see real damage done to our fiscal situation, including the wholesale debasement of our currency. And a lot of smart peeps will continue to warn and say we’re gonna pay a steep price for all of this at some point…and they are right!

From that standpoint, we are in serious trouble, no doubt! And the truth is we are theoretically in decline and on a path from which we can’t diverge. Our days as The Lone Superpower are numbered.

Pretty dire stuff, huh? YES, indeed!

But………there’s a silver lining here. We actually have something working in our favor – the very nature of POLS…and the relative nature of how the market views things. As such, we have to keep things in perceptive and remember all is not gloom and doom.

First up, the nature of POLS. True to form, the POLS did exactly what was expected of them all along – they were guided by their own sense of self-preservation and found a way to make things work…just enough…at the very last minute. Sleight of hand parlor tricks designed to fool and buy time…but not fix

Now lots of peeps are gonna be predicting this is gonna backfire immediately…resulting in a serious slowdown that will see us stumble into recession in the coming couple months. And it’s hard to argue with their logic. In my view, we are already slowing and the coming earnings season could be a tough one given the year-over-year comparisons that companies are gonna be facing. But you have to temper that with the fact that the bar has been lowered so much already that many will actually beat expectations – the typical Wall Street earnings charade. Whatever the outcome, this is a “relative” matter and not something catastrophic. I’ll come back to “relative” shortly.

Which brings me back to the nature of our POLS. It never pays to underestimate the power of a politician seeking to save their own skin… In fact, we’ve seen this very script play out in the recent past over in Europe with the sovereign-debt situation. They have been kickin the can down the road and seemingly tip-toeing on the edge of disaster for the past several years now. The situation remains dire still, yet they’ve avoided collapse and at this point have somewhat miraculously managed to create a perception that they’ve come up with the proper prescription to the whole mess and are now putting their house in order. Mind you, I said perception…

So how does that help us? I said this was gonna be twisted…but no less true. Should we expect anything less out of our elected leaders than those in Europe? Certainly not! They’ve always obliged and will do so this time around and at every point necessary in the future.

Trust me, they will muddle and mess things up, but this isn’t about what they are capable or incapable of – it’s all about understanding the simple fact that we can count on them to act in their best interest to save their hides and cushy positions. Translated, that means do nothing most of the time and kick the can down the road when absolutely forced to do something.
The fiscal cliff is proof positive of this. They created it themselves…a self-imposed diet of draconian austerity that was supposedly so unpalatable to all parties that resolution was an absolute surety – much like our policy of mutually assured destruction throughout the Cold War era.

Yet in the end they simply passed measures (after the deadline, no less) extending the deadline by a couple months. Laughable. Even more so is their feigned argument that this is about the American people. This has never been about ideology or a higher purpose or serving their constituents and certainly not about putting our fiscal house in order. And the whole “we don’t want to leave this mess for the next generation” rhetoric that gets bandied about by all sides…. Pllleeeeaaaaasssssseeeeeeeeeeee.

Granted, that probably sounds a bit jaded…

But in fact I’m actually an optimist and I view their recent actions as proof I can count on them to act in a certain manner. When the “stuff” hits the fan, our leaders (throwing the Fed in there as well) will absolutely wait till the 11th hour and then find a way to kick the can down the road. Whether you believe it or not, there is comfort in that. Very much like the wild horse that will run you right up to the abyss but stop at the edge due to an inherent instinct for self preservation. We aren’t going off a cliff any time soon…fiscal or of any other sort.
Which brings me to the relative nature of how the market views things. While our house is a mess in many regards, the fact is we just came back from the brink of financial meltdown – that’s not rhetoric or an overstatement of any sort. And the picture hasn’t improved much in the intervening years since the near implosion. Make no mistake, our debt and spending problem is a serious issue that is not going to get solved…EVER – especially by the very peeps responsible for the problem to begin with!

But the market understands this and factors the reality that our decline will come in measured tones and over a long period of time. Simply put, we aren’t going away any time soon. And we remain the best game in town from a relative standpoint…for now and a fair amount of time going forward.

Like I said, twisted….but no less true!

Now you can bet there will be peeps out there who interpret this to be a prediction of some sort of pollyannaish scenario – trust me, I ain’t been hittin the Cool Aide…at least not that flavor.

What I am talking about is getting back to normal market activity. Corrections and rallies and the occasional crash and some irrational exuberance mixed in.
Bottom line, while there are many issues to be dealt with still and we are far from being divorced from the actions of the POLs, both here and abroad, we do seem to be heading away from the constant barrage of catastrophe-driven distress in the markets that has most definitely prevailed over the past five years. Sure, that could change in a heartbeat, but there’s no denying the growing sense that we have entered more-normal market conditions – familiar territory where we worry most about the Fed, inflation, earnings, innovation and the types of things the market and it’s participants are used to dealing with on a daily basis.

Don’t know about you, but I’m ready for Wall Street to start leading once again as opposed to being shaken by the POLS…scuse me – I meant the tail.