by Andrew Adams CFA, CMT, Saut Strategy LLC

Charts of the Week

When I left my job last year in order to trade full time, it was like stepping into a whole new world. I thought I knew a lot about the markets after writing about them for years and doing a bit of casual trading, but sitting in front of multiple monitors every day to try to make a living off the seemingly-random fluctuations is a completely different animal from checking in on positions every now and then. There are almost limitless opportunities to make money trading, yet, ironically, those opportunities are difficult to identify in advance and the market will punish you very quickly if you make a mistake (or sometimes even when you don’t make a mistake).

Shortly after word started getting around last year about what I was doing, one of my friends reached out to me to ask if it was ok if his father could give me a call to ask a few questions about trading. I said, “Sure,” and a couple days later his father got in touch with me. I explained to him my basic trading strategy and he said he had done some trading back in the 1990s so it all made sense to him. And then he followed that up by asking me, with complete earnestness, that if I ever came across a “sure thing stock that was guaranteed to go up” could I send it his way.

I think I was speechless at first, but eventually replied with something like, “Of course, as soon as I find a stock that is guaranteed to go up I will make sure to share it with you.” And yes, that conversation really happened, but suffice it to say he and I are both waiting for that “sure thing” stock.

Follow Me @DayTraderGator on Twitter for Additional Thoughts

I do consider becoming a trader one of the best decisions I’ve ever made, but I don’t want to make it sound like it’s always a smooth ride or that I haven’t made mistakes. I’ve made lots of them, in fact. I still make mistakes, too, though I try my best to learn something from each and every one.

After a few weeks of full-time trading, I realized that when I did have a bad loss, it usually came from breaking one or more of a handful of rules; so, I placed those rules on post-it notes by my screens, and review them each morning before the session begins. These are mostly intended for my day trading, but I think most traders and investors would benefit from sticking to these general guidelines no matter their strategy:

• Follow the Trend
• Losers Average Losers [in other words, don’t add to losing positions]
• Cut Losses When the Stop Price is Hit

These rules don’t guarantee a winning trade, but they surely help minimize big losses which allows you to stick around long enough to make winning trades. One of the frustrating aspects of trading and investing is that you can do everything “right” and still lose money; that’s just a result of the vagaries of the market. Conversely, you can break every rule in the book and make money on a trade or investment through luck and random chance. Yet, in the long run, you obviously want to limit mistakes and bad practices as much as possible because eventually they will come back to bite you.

Another crucial thing that traders have to learn is how to adjust to the market on the fly. With the benefit of hindsight, it can appear obvious when inflection points are reached in the indices or an individual stock, but, of course, it’s not that easy to spot these reversals in real time. A good example of this fact took place over the last few sessions when the market did ALMOST exactly what I wanted it to do and yet still managed to make it difficult for me or anyone else trying to trade the move (more on that later).

Technical analysis isn’t a science and the markets aren’t math.

You can’t expect everything to work out perfectly like a formula or equation, especially at the moment when we don’t seem to go more than a day or two without some sort of “tape bomb” being dropped in the middle of market hours. Accordingly, the ability to adjust expectations and ride the wave of the market is critical at all times but particularly in this “trader’s market” in which we remain. Sticking with one set of expectations despite evidence to the contrary is not the way to make money in this market.

It’s not just about adapting to the day-to-day fluctuations, either; to get the most out of the market, one also has to adapt to whatever kind of market we happen to be in at any given time. Regular readers have likely noticed that I haven’t been holding many positions in my portfolio over the last few months of doing these reports, and there have been few cases where I’ve held something long enough for it to show up from week to week. That isn’t necessarily the way I want it to be, but it’s a result of the rangebound market that has made it difficult to hold positions for much longer than a few sessions. Most of my trades are day trades when I spot a possible quick opportunity, but for the multi- day holds I’ve tried to take profits when I can get them, cut my losses quickly, and limit my exposure to a market in which we’re always just a tweet or headline away from a position instantly morphing from a gain to a loss.

I’d love to be able to carry positions for longer, but it’s just a different kind of market than in 2013 or 2016-2017 when there were more stocks in clear, steady uptrends that were easier to hold. Back then, “buy the dip” was really the only strategy one needed, but now it’s more about identifying possible trading ranges and support/resistance and then adjusting as these levels hold or fall. I still believe it will likely require a clear breakout in the major indices to produce more and better opportunities for investments and longer-term trades, and unless that occurs the focus for most should likely be more on playing defense than offense.

Yesterday was a perfect example of why taking profits when you can get them has been so necessary. In the first half hour after the opening bell, things were looking good and the S&P 500 appeared to be breaking out over some key short- term resistance levels. It was a continuation of the decent bounce off of Friday’s support low, and, while market internals weren’t exceptionally strong, the move did temporarily flip the “path of least resistance” back to the upside.

But then 10:00 am rolled around and the ISM Manufacturing Purchasing Manager’s Index was released.

The report, which “is based on data compiled from monthly replies to questions asked of purchasing and supply executives in over 400 industrial companies” (source: investing.com), indicated that economic activity in the manufacturing sector contracted in September for the second straight month and is now at a 10-year low. Even worse, the pace of contraction accelerated over last month and the PMI number resultantly came in well below consensus expectations.

According to the release, “Global trade remains the most significant issue, as demonstrated by the contraction in new export orders that began in July 2019. Overall, sentiment this month remains cautious regarding near-term growth.” The poor Manufacturing PMI number yesterday might be “new news” but the uncertain trade environment and slower economy is most certainly not (the PMI has dropped by 11 points since last November — from 58.8 to 47.8). The odds of further easing by the Federal Reserve at their end of October meeting did jump from 39.6% to 62.5% after the PMI release, but that didn’t seem to matter yesterday.

The result was an S&P 500 that fell from 2992 to 2938 in the course of a few hours, an erasure of all the paper profits since Friday’s low. It’s no wonder, then, that investors and traders alike are hesitant to go all-in here when action like this is the norm.

If there was a silver lining, it is that the decline did (finally) completely fill the gap from September 5th before some support was found, but the subsequent thrust off the low wasn’t very convincing and as of this morning the S&P is back down trading within its August trading range of 2820-2940.

If you’ve been reading my thoughts lately, you’ll know that I did not want the index to return to this area. To be clear, it’s not exactly a doomsday scenario where you should sell everything you own considering the S&P 500 is still less than 5% from its all-time high, but it’s a definite step in the wrong direction, technically. When a bull market is strong, you don’t typically see major support areas violated so soon after a breakout like the one we got from the August trading range. Instead, demand picks up and the market generally accelerates to the upside away from the breakout point.

Yet here we are and so now we have to adjust on the fly. As I have written, the best case scenario after dropping back into this range will be to escape from it again quickly. If support is found in the next day or two and we see signs of strong buying demand then it may just be a false alarm. But I will be playing defense more than offense (and favoring shorts more than longs) while the S&P 500 remains below 2940 unless a clear buy set-up forms.

As mentioned in yesterday’s trading flash, there is a smaller gap from September 4th that would be filled with a drop down to at least 2914 and as I write at 6:00 am the S&P 500 December futures contract is hovering right around that zone. If it falls too much further, the S&P risks breaking down through the uptrend it has been in since late December, which would add to the technical woes (see page 8). It is, therefore, even more crucial that support is found sooner rather than later.

Below 2914-2915, I don’t see much obvious horizontal price support until the 2890-2900 area and then 2850-2855 below there. As always, that doesn’t mean the decline can’t stop somewhere else, but those are the likeliest spots and each time one of those support levels breaks it could add to the selling pressure.

So, heading into today my game plan, once again, is to play defense until conditions improve. I have already received a few “what should I do?” emails but I can’t answer that with generic advice that will apply to everyone. The best broad guidance I can give right now is to be extra cautious under 2940 and make sure you don’t let any individual position go too far against you. We will try to put out additional trading flashes, too, if the market gives us a reason to do so.

S&P 500 Sector Snapshot

Source: www.sectorspdr.com

S&P 500 Support/Resistance

If the S&P 500 does indeed open today below yesterday’s low, the question becomes where are the next likely support areas. As mentioned, the smaller gap from September 4 could be a target, with 2914 the lower end of that gap. Below there, we have the 2890-2900 area, then 2850, then the lower end of the August trading range around 2820-2825. Ideally, I’d like to see 2900 hold and the S&P trade back above 2940 quickly. As for resistance, with yesterday’s big move down there isn’t much obvious resistance above 2938-2940 until the same 2990 area that gave the index trouble the last few sessions.

Further Weakness Risks Breaking the Uptrend

Another reason I want to see the market find support sooner rather than later is that just a little more weakness will break the uptrend support line connecting the December and August lows. The breaking of a relatively steep ascending trendline isn’t necessarily disastrous on its own, but when combined with the red flag of falling back beneath 2940 and the “rising wedge” action in the S&P 500, a violation of the green line below would not be something I could ignore. Even falling below 2915-2920 would probably be enough to break it, so, here too, I don’t want the index to spend much time beneath there.

2925-2950 Continues to Act as Fulcrum

It’s easy to see on the S&P 500 weekly chart why there’s so much focus on this general 2925-2950 area. Over the last year it has been massively important, which is why we want to see support/demand enter here soon.

Similar Look for the Dow Around 26,500-26,750

It’s the same story for the Dow Jones Industrial Average, which is back to where it was at the late January 2018 high. That is one heck of a base to build on if the market does ever break out and pull away from it, but for now this general area continues to provide resistance.

Emerging Markets Pulling Back to Own August Range

Jeff Saut mentioned emerging markets in his Monday letter as a possible investment idea and they do appear to me to be interesting here. The iShares MSCI Emerging Markets ETF (EEM) is pulling back to its own August trading range where some support may be found, and it has actually looked better relative to the S&P 500 lately (lower panel). It did not fall as much yesterday on the decline and could be worth a closer look here assuming the world doesn’t come to an end.

Small Caps Still Trapped for Now

Small cap stocks have made no progress over the last year and remain confined with a broader trading range. The Russell 2000 now nears once again the lower end of that range where hopefully support will be found.

Market Back to “Neutral”

With the decline yesterday, the percentage of stocks on the NYSE above the 50-day moving average is back to around 50%. This is neutral territory and not yet down to the levels that typically mark significant lows (<30%). Like with support, the market doesn’t HAVE To hit levels below 30% to bottom, but the neutral readings do mean the market would have to fall further to hit the “washed out” levels that indicate stocks are oversold.

More 52-Week Lows than 52-Week Highs

There were more 52-week lows yesterday across the NYSE, NASDAQ, and AMEX compared to 52-week highs, another reason for caution. Usually the worst market declines only come after this indicator drops below 0 (more lows than highs).

NASI Declining

The NASDAQ McClellan Summation Index, which is a running total of the daily McClellan Oscillator values, is back to heading lower. The best time for long stock trades usually comes when this indicator is rising instead of falling.

S&P 500 Also Back to “Neutral” at 50-DMA

The S&P 500 is also back to trading around its 50-day moving average. It would have to fall to around 2895 to get one-standard deviation beneath the 50-DMA and to 2840 to get two-standard deviations beneath the 50-DMA (this changes daily). Hitting these lower standard deviation bands can often lead to at least a short-term bounce.

Semis Not Doing too Poorly

Surprisingly (and hopefully bullishly), the Semiconductor Index is holding up a little better than the S&P 500 and broad market. It remains above its August trading range for now and didn’t fall as much yesterday as the major indices. This at least supports a more minor pullback than anything major since the Semis often lead the broad market.

ISM Manufacturing PMI Not Painting Pretty Picture

While the stock market continues to hang on for dear life, the economy has already shown some cracks. Yesterday’s ISM Manufacturing PMI release was the lowest since June 2009 and continues a year of declines in the number.

Source: Jill Mislinski; dshort.com 18

Trade Ideas

As mentioned, I am more interested in playing defense than offense right now so not focused on individual long setups until the market improves. For potential shorts, I will focus on quick trades on the broad market (e.g. SPY, QQQ, IWM, futures contracts, etc.) rather than individual stocks.

When I look for trades, I am looking for stocks I think can move in the direction I want them to go quickly while limiting my downside if I am wrong. I expect to be wrong a decent amount of the time given the tight stops, but the idea is that the winners should more than pay for the losers. There is an opportunity cost to holding a position, as the capital allocated to it prevents you from using that capital in another position, so if I enter a stock and it doesn’t quickly do what I think it should I may cut it even though a stop or profit target isn’t hit. Likewise, I usually move my stop up to my breakeven point once the trade starts to go in my favor in order to prevent a winning trade to turn into a losing trade. Understandably, my trading strategy might not fit your trading/investing strategy, but the trades highlighted in this report are the kinds that I typically look for.

Current Open Positions in Personal Accounts (this changes daily): Long BIDU, Long ARKK, Long VIX Oct 15’19 18 Calls

• • Investing/trading involves substantial risk. The author and Saut Strategy LLC do not guarantee or otherwise promise as to any results that may be obtained from using this report. Past performance should not be considered indicative of future performance. No reader should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence, including carefully reviewing any prospectus and other public filings of the issuer. These commentaries, analyses, opinions, and recommendations represent the personal and subjective views of the author, and are subject to change at any time without notice.

  • The information provided in this report is obtained from sources which the author believes to be reliable. All charts are from stockcharts.com unless otherwise stated.