Current State of the Market/ Q&A

Hey guys. Thanks for submitting some Qs. I'll start by just briefly discussing some thoughts on the state of the market right now, what's been happening, and opinions on why.

I was having a discussion with one of my trading partners the other day, and we were just going over what's transposed over the last week or so and talking through the cause of this sell off. You can try to use all your brain power and come up with the most complex explanation you want, but as with most things in the market - the real answer is usually much simpler.

What really makes the market move? For the most part, the answer is catalysts. Forward looking events. For the last year or so, it seems the markets have been "pricing in" this recent tax cut plan. And usually, the markets never get it right the first time around. Moves are often overdone in both directions, and then add in investor emotion, and you end up with an overshoot. What appears to have happened is a large overshoot to the upside, and now that the tax cut plan is here - the forward looking event is over, and we're left with correcting the overshoot. I'll use the S&P as a guide in this discussion. The whole thing started shortly after the election of Trump, when the S&P was around 2400, and we've basically went straight up since. On January 26th, we hit a high just shy of 2900, and currently as of this Friday, we sit at about 2620. Once the forward looking catalyst (the tax cuts) came to fruition...now what? It goes back to one of the most basic concepts of market movement - sell the news. It looks like over the last two weeks for the most part, we're seeing some profit taking, from people who were doing all that relentless buying on the way up, now "selling the news" that has been baked in for months. It's natural, it's healthy, and necessary for these moves to happen. We can't go straight up forever. 

There are other contributing factors as well. For one, the tax cut is an incentive for profit taking all on it's own, as people now will be paying far less of a commission to Uncle Sam on their gains. Then there's the 10-year Treasury yield that's been creeping up since September and is now approaching almost 3%. This is really the main "competition" for the market since the death of money market accounts years ago - as funds & investors with large amounts of money, being able to get 3% somewhere else is very appealing and a nice return. It's an incentive to move money out of stocks and into these other "safe havens" that have been beaten down for a long time making them rather unappealing, and by default, making the equities market the only game in town. Also another reason, back to the forward catalysts concept - is the discussion of potentially up to 4 rate hikes this year, that's a negative for equities as well. So the positive catalyst, the tax cuts, is over, and now we're left with the Fed comments, being a somewhat negative future catalyst for now (for the equities market). There are other contributing factors I'm missing here as well, but these are a few of the main ones. 

So when you take all these things and put them together - the outcome is likely what you've been seeing recently - a fairly aggressive and nice hearty pullback and profit taking. I don't think the market is collapsing or we're doomed or heading into a bear market for the rest of eternity - but I do think we will experience some turbulence for a few more months. Again this "no red days" madness really started to accelerate from around 2400 in the S&P around September. So the thought would be, that's likely where we will eventually work our way back down to and retest before continuing higher. 

This past Friday that was a pretty wicked bounce in the afternoon, and the springboard spot, roughly 2530 in the S&P, was no coincidence. That was right where the daily 200MA sat, which is a number that investors are typically very keen to as a support area on a chart. So naturally when we tested that spot, some technical buying surged in there. But in my opinion, it was just that - technical buying. My gut is saying we will still retrace lower and give that back. Typically whenever a "real" bottom forms, you see some panic selling into it, sort of like a "climax" or confirmation, similar to the buyer/seller exhaustion concept I talk about in my intraday trading. A "Tipping Point" if you've read the Gladwell book. And really on Friday, it was nice orderly selling on the way down, there was never really any feeling of panic, not in my opinion at least. So I don't think we're done with the selling overall. We'll see. But that was a brief overview on what we think we've been seeing over the past two weeks, hope it gave some clarity if you're unfamiliar with the macro side of the markets. 


Lets get into some of the questions.

Totally different. I really encourage anyone new or inexperienced with ETFs to stay away from VXX/UVXY. I was talking to my buddy about these two last night as well, and he said to me "I challenge you to tell me what the hell UVXY or VXX even are. Like actually explain to me what the instrument is, and how it moves." And I thought about it for a second, laughed, and agreed. We don't even know what they really are. It's an instrument that was engineered by someone for a very specific purpose, and it's totally unnatural and untrue to anything else regarding typical price action. We don't even really know what they gauge. We have an idea - volatility, the VIX, the SPY, hedging, emotional turmoil, premium decay, wrap all those things up into a ball and you have an instrument on bathsalts in times of high volatility that is very unpredictable on an intraday basis. If you catch it at the right time it can yield amazing returns, but catch it at the wrong time and you're dead. Try to buy a dip and be down $3 before you can blink. Short overnight and watch it run $5 after hours out of nowhere. Basically VXX/UVXY is a weapon of mass destruction designed to sell, for the most part. In the grand scheme of it, all it does is split, and sell. It's sole purpose is a form of hedging, and retail wealth destruction. If I trade it at all, I almost always look to short it, as that's the natural direction it wants to go. There are times the edge is in your favor to short it when there's a ton of premium decay built in (like Friday afternoon), but it's actually a lot harder than it looks to trade it. Some traders will make a killing on it and more power to them, but for most traders - it will probably hurt them more than it will help them. I would say avoid these things if: 
1) You have a small account, as margin requirements are ridiculous on them at most brokers (be especially careful at Vision not to generate a Day Trade margin call, as the only way to rectify that is by wiring in any money over 1:1 you use in the trade, money you may not have)
2) You are not incredibly comfortable with trading volatility & momentum. 
3) If you're very risk averse, as in one of those "I'm looking to risk .15c to make $X whatever - if that's your style, these ETFs are not for you. 
I'm not going to get into it much more here, but the short answer is no, it's nothing like a normal stock parabolic. 

I know you watch my videos as I saw your tweet yesterday. (Nice setup btw!) So I go over this question in detail in "The Perfectionist Trader" video, watch that again for a majority of this answer. As for when to size up, that's not a black and white question to answer, it will vary for everyone, it's an individual comfort factor that varies for every trader, I can't tell you when to do that. But all I will say is to do it very slowly.  Rushing the process trying to make big money too soon is usually when things go wrong, so don't succumb to that. 

Well the actual number of located shares is relative to where you're at with size in your journey of course, but the main thing that determines how many shares I locate is the float & the volume.  If it's a 1.5M float stock with a big spread, I'm not going to go locate 30K shares, that's foolish. The slippage trying to get in and out will be insane. The liquidity has to be there. But if its something like MNKD, or a stock with a large float 50M+ and it's trading high volume, you can pretty much locate however many you want. Also depends how far it's ran, what day of the run we're in, and your conviction. But overall how many shares I locate is a direct result of the float & volume of the name for me. 

No, trading largecaps and small caps is very different, and I employ different strategies for both. Smallcaps I prefer to look for the best ones & try to swing them short and make money with patience, where largecaps are more intraday scalping strategies for me, and they tend to more closely follow what the market is doing, especially in times of volatility like right now. 

Not really. I'm sure there's plenty of other stuff out there, but not that I have experience with. You pretty much just mentioned everything I did - I got a foundation from IU videos way back when to learn the basics, and the rest has been putting my own unique spin on everything through screen time/trial&error and talking to other traders and picking their brains. 

I have no idea. That's not really what I focus on, I'm not big on trying to predict what's coming, just take it one day at a time and trade what's in front of me. 

Well you can't avoid it, especially if it's going to be like this for a while. I have no idea if it is or isn't, but our job as traders is to find an edge, in any market. You can certainly become less active in an effort to preserve capital and minimize stupid mistakes, but you can't avoid it altogether, especially if trading is a main source of income for you, you have to figure it out. Best thing to do is go after the stuff you're unfamiliar with in smaller size increments, and see what's working for you and what isn't. 

Sure. I think that happens in smallcap land more often though. There are periods where they gap and crap and everyone is trained to short early, and eventually that stops working, algos catch on and flip the script, creating traps and epic squeezes, and we have to adjust again. It's a constant cat and mouse game there. But you can probably make the argument for any instrument in the market - as more and more people gravitate toward something that's working, the less likely it is to continue to work. 

It's a tough decision. Would be hard to say here as it hasn't been that long yet, only about two weeks right now. But it never hurts to expand the playbook, I think moving to largecaps or certain ETFs are good skills to have regardless, so yes I definitely recommend trying to dip your toes in there with small size to try and find something that works for you. 



Thanks for the Qs, hope this was helpful. Enjoy the rest of your weekend. 


- D