Do Less, Cut Position Size

The best traders and investors know when to be aggressive and take advantage of a healthy market and when to slow down, do a lot less and protect capital. Everyone makes money in an uptrend. Not everyone keeps it when the inevitable choppiness comes.

If you expect the media to tell you that we are in a correction, you will have to wait for a 10% pullback for that to happen. This is not helpful. We have to observe the subtle changes in market character and manage risk proactively and in real time.

After the reversal on May 22nd, I mentioned that we have entered a new market environment that will require tactical adjustment. The chasing is not going to be mindless anymore and we are likely to see a lot of false breakouts and breakdowns. Overly active traders that fail to recognize the changes are likely to suffer a “death by thousand cuts”.

So has the market changed? Look at the 30 min chart of the $SPY below. One of the better definitions of a healthy trending market is one that trends above a rising 5 day moving average (which was the case for the better part of May) or below a declining 5 day moving average (which we haven’t seen since last November). The new reality – high volatile choppiness. The $SPY pierced through its 5 day moving average (which on a 30 min bars is 65-period MA) seven times over the past seven days.


The St50 list gained 0.5% for the week, but under the surface there was a lot of damage that became especially pronounced on Friday afternoon and many of the price leaders gave back a substantial part of their weekly gain.

The weakness on Friday was all-encompassing, but especially heavy in energy, basic materials and emerging markets. The St50 list managed to finish green for the week only because it has very little exposure to those sectors.

There were four earnings reports on the St50 list last week – all of them saw relatively positive market reaction: $KORS $SPLK $LGF $GWRE.

What else important happened last week

The most interest rate sensitive assets continue to get clobbered in an accelerated fashion as fears of the FED tapering its monetary efforts are driving the yield higher across the whole risk curve.

Screen Shot 2013-06-01 at 7.19.42 AM

The financial sector exhibited notable relative strength.

This is what happens in an environment of rising interest rates expectations. The yield curve is getting steeper. People are more likely to borrow today if they expect the cost of borrowing to rise tomorrow;

Market exchanges and brokers are also seeing buying interest as the market is betting that people’s interest in equities is gradually returning.

The Ultimate contrarian indicator resurfaced. A non-business media featured the stock market in positive light on its cover. Covers are not a precise timing tool, but it is something to keep in mind as financial markets are often counter-intuitive to common Main street’s logic.


Consumer confidence is at multi-year highs. Apparel retailers had a decent week.

Corporate buybacks continue with full force.

Priceline issued convertible notes for $1B to finance stock repurchases. Data shows that most of those buybacks are done to mask the dilution caused by executive stock options. Nevertheless, it is a net positive for the shareholders in short-term perspective. Long-term, not so much – companies are increasing their debt levels and buying back assets at very high valuations. Everyone is myopic and everyone is focused on short-term results, so this is what we have. Borrowing for buybacks is the most popular game in town and everyone is playing it, which puts an underlying bid for equities. The bull market in the mid 80s was also fueled by buybacks. The difference is that this time, the interest rates are a lot lower.

There is no scarcity of good looking long setups on the St50 list and in the market in general – $CHUY $AMBA $CERN $PRO $CERN $EFII $ININ. In high-volatile, choppy environment, the success rates of breakouts is a lot lower. Many will either fail to follow through or deliver much smaller gains than usual. Welcome to the range-bound market reality. The more active you are, the bigger the damage you are likely to cause to your capital. One way to deal with the new reality is to do less and cut position size.

See the latest St50 list here.