There is a Difference Between What People Say and What They Think

For many, there is a difference between how you think you will act in certain conditions and how you actually act when the time comes. The term used to describe this condition is called empathy gap.

There are two basic scenarios in which empathy gap can impact your performance as a trader/investor:

– you don’t cut your losses when they hit your pre-established exit level. This is the single biggest reason, so many people struggle in the capital markets. One solution to the issue is to enter exit orders, immediately after you initiate an opening order (caution: it does not work with illiquid names, where market makers can easily shake you out);
– you don’t take the signals from your watchlist when they are triggered. Some stocks can really move fast after they pass their tipping point. When that happens, many traders feel like a deer in headlights and are not willing to pay the market price. They’ll put a limit order, hoping that the desired stock will come back and their order will be filled. The best stocks don’t come back. Don’t be afraid to pay the market price for proper breakouts.

In his latest post, Steve Martin reveals that:

In today’s information overloaded world, evidence suggests that 95 per cent of our decisions are made without rational thought. So consciously asking people how they will behave unconsciously is at best naïve and, at worst, can be disastrous for a business.

This is one of the reasons why I think that survey based sentiment measures have little value. Market sentiment is reflective. It mirrors short-term price action and recent performance. For example, people who have had a number of consecutive successful long trades are likely to be much more optimistic about the markets in general than people who have been on the sidelines.

I realize that there are some hedge funds that claim that sentiment could be a leading indicator, but I have a feeling that in their case they are confusing correlation with causation. The truth is that price and sentiment live in a systemic relationship, meaning that they mutually impact each other in real time. Price changes when perceptions of risk change, but also perceptions of risk change when price changes. Since I don’t have a reliable method to catch changes in sentiment, my starting point for finding new ideas is always price.

Focus on Strength

3 back to back green days for the market averages with $QQQ breaking above its 50dma intraday and reaching levels not seen since August 2nd. None of the macro issues have been resolved, but they never will be. For better or for worse, the market has a short-term memory and is capable of rallying in any environment.

The mainstream media continues to mass produce apocalyptic news, because this is what attracts the most attention and sells the most. When the current challenges are solved, it will come up with something else to worry about. It always does. People do what they are incentivized to do, and TVs and newspapers are incentivized to produce noise. The good news is that you can fully ignore it when it comes to making your trading and investing decisions.

Focus on strength, take your entry signals and diligently cut your losses. Loss cutting is not practiced only to protect capital against major drawdowns, but also to consider opportunity cost – there are always other stocks that are breaking out or down. If one idea does not work, just move to the next.

Take a glance at $STMP, which has become the latest posterchild of why relative strength matters. When a stock is up 3% and advancing while the market averages are down 2%, take a note. This stock is likely to outperform when the market turns north. BTW, $STMP is extended at this point and this is not the place to chase it.

Let’s take a look at the breadth:


Other Stocks that are less than 5% from their all-time high: $VRUS $MAKO $KEYN $STAA $AMZN $MA $ALXN $JAZZ $ULTA $HANS $EVEP $MG $TNH …

120 liquid stocks gained 5% or more today. 35 of them reached new 20day high. Some of them: $SQNS $SIMO $NVDA $BSFT $TLEO $CRUS

330 liquid stocks reached 20-day high at some point today: $ARMH $CMI $URI $BMC…

Look, things can change in a blink of an eye. Chasing stocks that are up 3 days in a row is not wise. Taking gains relatively quickly and keeping your overnight exposure light still makes a lot of sense.

Where is the Strength

Over the past month, it has become a tradition for the stock market to rally at the beginning of the week and give back the gains at the end. Elevated volatility and 1% opening gaps have become a common occurance. This type of market environment has conditioned most of us to take profits quickly and limit overnight exposure to a minimum. This is natural. No one wants to wake up leveraged to a 3% gap in the opposing than the desired direction and the current headlines driven market is absolutely capable of everything.

Macro-wise, nothing has changed. Greece is still bankrupt, just like it was last year at the same time.  The difference is that now capital markets care. Why now? Maybe it has something to do with a cyclical global slowdown in the face of  overleveraged governments in the Western hemisphere and an increasing inflation in the emerging market world. No one knows for sure.

Let leave the macro analysis to the economists, and take a look at the price action. Two weeks ago, I mentioned that September won’t be like Correlation 1.0 August. It would be a market of stocks and so far I’ve been proven right. If your watchlist consisted of stocks like $ATHN $MAKO $STAA $VRUS $ULTA $PANL $WPRT $QSII… you wouldn’t even know that the market averages are in trouble. Focus on what you can control – the stock you trade, your entries, your exits and your position sizing.

Now is certainly not the time to be aggressive and to chase, but if you are looking to initiate some new long positions, the following suggestions could be a good starting point: