A Dangerous Market Full of Crosscurrents

May 4, 2012
By

click to enlarge

I recently had the opportunity to go out for drinks during the week. I turned it down, saying I can’t consume alcohol on a school night.

Friend’s response: “You mean a work night?”

“Nope. For traders they are school nights — because if you don’t rest up and do your homework, the market schools you good.”

Within the context of the Mercenary trading style, doing our homework means staying on top of key developments, both fundamental and technical.

And not just somewhat on top of things, but COMPLETELY on top of things — “like Pamela Anderson on a can of spam,” as an old colleague used to say.

(Not sure what that means exactly, but it stuck…)

Anyway, in the interest of maximum awareness, we recently added a feature to our flagship advisory service  — the Live Feed Trend Tracker, as shown on right. (Click image to enlarge.)

In addition to the market analysis and top down perspectives you see in the main post stream (and receive via the Mercenary Dispatch), we regularly broadcast more portfolio-specific and trade-action specific material — including real time trade executions, position sizing guidelines, portfolio dynamics, and more — within the Live Feed.

Below is an example of our open book thought processes, posted to the feed stream early this morning (prior to the day’s carnage). To find out more about the Live Feed — or get a free 14-day trial — go here.

Danger Will Robinson!

1:41 am – May 4, 2012

This is a dangerous market with lots of crosscurrents. The major indices (Dow, S&P, Trannies etc) are right in their most precarious spot — threatening a breakout to new highs, but also threatening to break down and fall back into the wide-swinging range that’s been in place since mid-March.

Bulls look at the charts and see healthy “backing and filling” action. Problem is, the fundamental backdrop to this market is scary too. Lots of potential hand grenades out there — like European elections this weekend, for example, or various econ data points with the ability to spook markets one way or the other.

The trend tracker is still chock full of “caution” lights. Plus we are seeing budding uptrend breakouts getting smashed in the mouth with no warning. Just look what happened to semis and energy stocks on Wednesday Thursday — two groups that had bullish patterns the day before (click to enlarge):

Our portfolio exposure levels are pretty small right now, and we are happy to keep ‘em that way. Maximum trading profits are not accumulated at a steady drip-drip rate day after day, but over the course of repeating market cycles.

Within a market cycle, there will be times when conditions are excellent — that’s when you want to be trading big. Then there are times when conditions are crap — that’s when you want to be trading small.  Big profits are compounded through a combination of both: Exploiting excellent market conditions with smart aggression, and minimizing danger when conditions are subpar.

Within the next few trading sessions, there are two ways the markets could go:

  • We could see a strong report or two plus benign Europe outcomes, leading to “risk on” relief rally and indices breaking out to new highs.
  • OR, the fit could hit the shan in one or more places — terrible jobs report, scary Europe result etc — causing the majors to fall hard with renewed possibility of bearish downtrends to develop.

The first scenario is the less desirable, from a trading perspective, because 1) bullish setups are so scarce, and 2) because underlying fundamentals remain so precarious.

The second scenario is more desirable because, if the market begins a strong move lower, it will cause a lot of overbought stocks to “clear”, setting them up for a good crop of bullish patterns later — while providing good short opportunities here and now over a month or two of correction (if not longer).

We don’t get to pick the scenario, but we do get to choose our reaction. If we get scenario 1), a bullish push to new highs, we will consider that reason to grow even MORE cautious, as a move higher here would be more risky and silly than constructive. In this event we would probably keep hunting for swing opportunities, but reduce trade size as a function of minimizing exposure in crappy market conditions.

If things break to the downside, however, we will be more open to exploitation, as the embedded profit in a nice correction could be substantial…

So strap in once again and get ready for some turbulence. The next few days (Friday and on into next week) could get a little wild.

Once again, if you want more insight into how real traders, deploying real capital, make integrated portfolio decisions in real time, go here.

wondering where the rum’s gone,

JS

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