This post is in tandem with my latest podcast. If you prefer, you can hear an audio version of this write up by clicking the play button below!
One of the most interesting things about running a service is being able to see the market’s, and traders’, irrationalities on full display on a micro level. I’m able to see first hand the “individuals” that I am “up against” on a day to day basis. The great thing here is that I get a glimpse of the mistakes that are made day in and day out and am able to refine my own methodologies without necessarily making the mistake myself. With that said, the single most frustrating error for individual investors/traders is their inability to sit still.
For the better part of a month I have been telling those in our chat the best trade is to sit still and wait fo the market to give you a proper setup. For someone who is active (last year I paid nearly $220,000 in commissions) I put on an average of ~3 trades per day for the month of May. For me, that is basically zero. It has been frustrating to see the days that they run stocks that I “would” have bought in a healthy market and doubly frustrating to see them stop me out of a position only to run it shortly thereafter. But the discipline has been crucial. Doing nothing has been the primary way that I have avoided losses in this environment.
It sounds cliche or just some regurgitated nonsense to suggest to people that “doing nothing” is the best case scenario for them. In the four years plus of doing this however, I’ve found that it is much better/easier to suggest this in times of dull markets and/or uncertainty than to try to get people to grasp the concept of selling/collecting premium. Especially since people struggle with directional bets as much as they do.
The main problem with trading options directionally in a dull tape is that with options you not only have to get the direction correct, but also the time and velocity of the move correct. In an elevated volatility environment this means that you have to be extra accurate with your assessment to profit from buying an options strike. During the past month there have been many instances that we’ve seen first hand in which the stock moved in our direction but the premium did not reflect such a move. This made for an even tougher environment. There were also many days in which a stock would start on the lows only to break higher and yet again only to break back to the lows late day.
There was also a stark bifurcation in May that made for an even more difficult environment. Stocks that had spent years trading in tandem no longer did so. They started to behave independent of one another. The FAANG stocks started to trade independently for example. One day you could have seen GOOGL up and FB down while the next you could have seen them all down with AMZN up etc etc. This “squishy” action, as I like to call it, made for a very difficult environment and a lot of “waiting” was done.
Lastly, with the bifurcation and squishy action came a headline driven market that made no sense both up and down. One day we were headline driven upwards on the speculation of a “trade deal” while the next we found ourselves wiping out all the gains and then some.
So let’s just focus on the number of variables we had to overcome in order to profit on a directional bet:
The time frame
Whether or not our stock would fade midday
The increase in the number of variables made, and makes, for a difficult time trying to trade directionally. So in instances such as the month of May, it is ideal to wait for one of two things — The market turning in one direction or the other, or a stock that will trade independent of the overall headlines/market.
During the difficult markets it is important to try and find trades that will move independent of the overall market. Specifically, and ideally, try to find a momentum stock that is trading absent all headlines and seems to be dancing to the beat of its own drum. Absent that type of stock, I like to find a stock that is primed to move technically on multiple time frames. In weak/confused markets personally I look for stocks on the verge of breaking down along multiple time frames. I prefer the breakdowns because in confused and weak markets the impetus to sell is typically greater than the impetus to buy. So you will find more bang for your buck trying to short a stock that breaks multiple time frames with a catalyst.
To highlight the above “independence” I will show TSLA’s setup in the month of May.
Since 2013, TSLA has risen from the lower left to the upper right pretty steadily. Secondarily, the stock had found support in the last two years at around the 250 level. It also enjoyed a nice range between that 240-250 level and the 370-380 level. (Both highlighted below)
Since breaking out in 2013, TSLA has enjoyed the benefit of a “cult-like” investor base. With major shareholders holding the stock for years as they believed in the “vision” that Elon Musk presented them with no matter how “out there” it seemed.
This “narrative” however started to turn this year as the investor base started to grow weary of TSLA’s outlandish CEO and his antics.
In April we learned that T Rowe Price, one of TSLA’s most ardent and largest bulls slashed it’s holdings by 92% in the previous quarter. We also learned that six funds in total cut 100% of their TSLA exposure. With that information, we were able to deduce that the investor base had grown “sour” on the stock in general. But what’s more important is that with such supply coming onto the marketplace we were left with a fundamental question; Who would support the stock should it start to break down?
The second major issue was that TSLA’s bond market was showing investors a weary sign as bonds that were set to be due in 2025 (and otherwise) were trading at a stark discount. This came on the back of a Moody’s downgrade in March and the company’s bonds and debt holders were not getting any sign of relief. This basically told investors that the company was at best risky and at worst on pace to potentially default.
So with all of this, the stock was basically skating on thin ice. And in a market like the one we had in May, that set up for a disastrous breakdown potential.
Just like that, TSLA’s investor base had soured on the stock and it was in danger of breaking down. On April 25, the stock did just that, it broke down along its trend started back in 2013. The following day the stock continued its downward momentum as it broke its three year range as well. From that point forward, a short on a breakdown of any “support” that stock had set in the short term equaled a great risk reward trade as momentum was now to the downside. The stock then attempted to regain the multiyear trend before ultimately failing again and beginning its bigger downward move.
With TSLA’s inability to recapture momentum and bounce back above its 5Day MA the stock continued its downward trot towards the 180 multi-year support. That is where RSI reached bearish levels not seen in years and the stock ultimately found a floor to trade off of.
The point here is that had you tried to short the stock earlier than when it finally broke down you may have not had a profitable trade. However, once the fundamental story had shifted, the demand had shifted, and ultimately the technicals lined up it was all systems go for the downside.
When once loved stocks like TSLA end up finding themselves in situations like this the selloffs are nasty. What once worked for the stock now does not. This was evidenced by the company attempting to allude to a “China story” coming out without any luck of saving the stock. The irony here is that it was just one year ago that the stock found itself in dire straights and was “rescued” by the “Funding Secured” tweet.
The key take away from this is that though it may seem like it’s “bullshit” there are actual times where doing nothing is the best scenario for traders. There is in fact a time for siting and a time for doing. TSLA is just one example of waiting a stock setup during the month of May instead of actively trying to take setups. Other events included the FB AAPL and GOOGL headlines that came at the end of last month/beginning of this one along with dozens and dozens of others. I’ve been fortunate enough to have found success in this industry.
I have found that the harder you have to “work” for a trade, the less profitable it has been.
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