Archives for May 4, 2018

Trading, Fast And Slow

In Daniel Kahneman’s excellent book, Thinking, Fast and Slow, he investigates two systems of thought. The first is quick and automatic. The second, more focused on complex issues. Both employ heuristics, but in different ways. Both involve non-rational thinking.

While I am borrowing the title and the general approach, it is not a perfect analogy. So much volatility driven by minor snippets of news. It is time to think about why.

Market Heuristics

The human desire for an explanation for everything drives social media. There must be a reason! The PBS NewsHour show today attributed the stock rebound to economic news. Forget that such news was reported either before the opening or in the first thirty minutes of trading. Other sources assigned different explanations, but none were very credible.

In the last two weeks, we have seen multiple examples of “trading fast.” Here is how it works.

  1. There is a news-driven stimulus. These are all actual examples.
    1. There is a raid on the office of the President’s lawyer;
    2. One semiconductor company provides a clouded outlook;
    3. A tweet or an overnight speech hints at a change in trade talks;
    4. A news conference suggests higher (or lower) tensions with Iran or Russia.
  2. Traders react. Most people do not understand the basic trader approach. You often “take a leg” leaning in a direction that seems to capture the mood of the market. If it goes your way, you ride it. If not, you try to scratch it for even or a small loss. Every piece of news has a simple evaluation: bullish or bearish.
  3. Algorithms react. The top computer systems have learned the keywords that are associated with market moves. These are even faster than the traders.
  4. Technical traders react. The market reaction may send stock prices through levels widely viewed as important support or resistance.
  5. ETFs that hold the key stocks plummet. Other companies in that ETF get slammed, even though their fundamentals are essentially unchanged.
  6. Financial TV brings in the chartists, who cite the temporary breach of the 200-day moving average, the move of averages into “correction territory”—more than a ten percent decline, and the level of decline possible in a Fibonacci retracement. Take your pick!

The least valuable heuristic treats the market as a war between two sides. This approach offers comments like the following:

  • The bears are in control
  • The bulls must defend the 2500 line
  • The bulls are absent – a buyer’s strike

And many similar statements. This is an entertaining way to (over-)simplify the market. We can all visualize a two-player game. Few can think about the wide variety of groups that are actually represented. Let’s turn to some facts.

The market participants

Those focused on daily news and an excessively frequent review of account statements might make a trade. More importantly:

  • The clear majority of investors and managers were doing nothing;
  • At the investor level, people were not even aware of the market volatility, at least until the evening news;
  • The field was open for System one, short-term thinking.

The events

What is the rational interpretation of key events? This is just a starting point for astute readers.

  • China response on tariffs. Pretty mild and not a surprise. It is a routine part of the current negotiation. If anything, the overall prospects for compromise have improved.
  • Trump attack on Amazon (NASDAQ:AMZN). More of the same.
  • Chip stock conference calls – basically good as confirmed by Apple (NASDAQ:AAPL).
  • Overall earnings reports – new records, despite the few clunkers.

Conclusion

If you try to “trade fast” you are competing with top-flight competition. If you have analyzed stock values, and can ignore the noise, you may find it very profitable to “trade slow.”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Buying The SPY Dip

Introduction

Over the last three monthly stock expirations, we have successfully traded the SPDR S&P 500 Trust (SPY) or other market tracking ETFs – both long or short – into option expiration. Here is a public record of those trades.

  1. In February, we outlined our long position in SPY,
  2. In March, we outlined our short position in QQQ, and
  3. In April, we outlined a long setup for QQQ (we were long SPY at the time).

When the SPY broke below its 200 day moving average today, with many people calling for lower lows, we initiated a long trade in SPY at under $260/share and shared this information with our subscribers. We had actually exited a SPY long earlier in the week when SPY was struggling with its 50-day moving average.

The chart below shows the price action in SPY over the last six months. It has essentially been trading between its 50-day and 20-day moving averages since February with a lot of volatility. The point of control is near $267, which is also near its 50-day moving average. In this case, to reduce our risk profile, we also sold calls at the $267 strike with a June expiration. This will enable us to profit from the elevated volatility.

Source: Think or Swim

OPEX Price Magnet

I created the concept of OPEX Price Magnets in June 2017, and have seen how the value of stocks and commodities have tended to exhibit mean-reverting behavior in and around the option expiration date. One point of mean reversion in many markets has been the point where the market is delta- or gamma-neutral on a given options expiration date. We call this point the “OPEX Price Magnet.”

The graph below shows the relationship between the S&P index price and the Price Magnet since February 2018. An introduction to OPEX Price Magnets can be reviewed by clicking this link.

Source: Viking Analytics

The chart above plots two daily data points, and the table below shows several more. June 15th is actually a more meaningful option expiration date than May 18th, since this is the quarterly expiration, and there are considerably more options in open interest in June than there are in May (note the highlighted Magnet Strength below). As a result, we believe that the quarterly expiration Price Magnet will help to keep the S&P index (and the SPY ETF) above the danger zone. It is also possible that stocks will rally substantially above these levels, and possibly mean-revert back later.

In addition to the S&P 500 Index, the Powershares QQQ (QQQ) and the iShares Russell 2000 ETF (IWM) are both suggesting that techs and small caps could rally modestly in the days and weeks ahead. This gives us more comfort in our long position.

Note: All charts above were taken from Trading View unless otherwise indicated, and all tables were created by Viking Analytics unless otherwise indicated.

Disclaimer: This article was written for information purposes, and is not a recommendation to buy or sell any securities. All my articles are subject to the disclaimer found here.

Disclosure: I am/we are long SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.