Momentum Monday – Choppy Market

MarketSmith powers the charts in this video.

The S&P 500 and the Nasdaq Composite rallied to their 50 and 20-day moving average where they were rejected. This could be the beginning of a new leg lower or at the very least more choppiness in the coming days. The gap and fade in Nvidia are not helping the Bulls’ case either. They just had one of the best earnings reports in their history and couldn’t hold their gains. Many stocks tend to top when they sell on good news. I am not looking for a top in Nvidia. The stock is still above its 20 and 50-day moving average and it is still in a clear uptrend but I am not looking to enter it right now either. 

A major source of active traders’ edge comes from using tight stops. Tight stops allow for small losses and winners that are much bigger than the losers. It is challenging to swing trade stocks with tight stop losses during volatile, choppy tapes. It is almost guaranteed that you will get shaken out. Small losses can accumulate fast even if you use a relatively small position size. Drawdowns lead to frustration and a loss of confidence. This is why it is so important to be aware of the market environment and what works in it. Keeping a large cash position, trading less, and using a smaller position size is not a bad approach for many here. If you have to trade, intraday makes the most sense currently because it is easier to find tight-stop entries and good risk-to-reward setups. If you prefer swing trading, consider using options to buy premium. The beauty of options is that you know exactly how much you have at risk – usually the entire premium. This provides you with staying power – you are less likely to get shaken out. It doesn’t matter if the market gaps against you. The most you can lose is the size of your premium. This is why you manage risk in options via proper position sizing. If you assume your risk is x, you will either lose x if wrong or make multiples of that if right. 

The tape remains volatile with a clear distribution under the surface. Most of the momentum stocks that had held relatively well in the past few weeks are getting hit one by one. If you are hiding in names showing relative strength, it hasn’t been working that great in this choppy tape which tells me that this correction might have more downside room. The stocks that are outperforming on green market days tend to be the ones from the bottom of the pit or highly-shorted names. We should see leaders starting to outperform if the correction is coming to an end. Many of the leaders are usually on my Momentum 40 list.

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