The IPO pond has dried out in the past year, but it has remained an incredible source of trading ideas. Due to their small float and newness, some new public companies tend to significantly outperform during rising markets and significantly underperform during market corrections.
Here’s a list of the nine hottest new stocks for the past year. Many have already had their run and are due for a pullback. Others are setting up again.
A good trader should be able to adjust to changing markets. 2 to 20-day swing trades work beautifully in steadily rising markets. We experienced those for the most part from February to August 2016. Intraday trades are the real money makers during corrective markets. Volatility spikes during corrections and when volatility spike, three things usually happen:
1) Stocks trade in much wider daily ranges than usual. The intra-day moves are humongous and there’s plenty of liquidity behind them. Upside and downside moves that used to take 5-10 days are taking 2-3 hours during corrective markets.
2) There are many reversals. Many breakouts and breakdowns fail. Stocks gap up one day and then gap down the next. Such environment makes 2-20-day swing trades more challenging. Even if you trade in the direction of the general market’s trend (which is obviously down during corrections), you will have to go through numerous high-magnitude squeezes until you get paid properly. The only way not to get shaken out from normal price reactions is to use a very wide stop and a smaller position size.
3) Correlations between stocks and different asset classes rise as well. This means that stocks bounce and dive together regardless of individual company’s merits.
Speaking of rising correlations, what makes a strong impression in the current market pullback is how many stocks are holding extremely well and don’t pay attention to what the indexes are doing:
Small-cap biotechs, many of which don’t have any earnings or revenue, continue to break out and gain ground. In a typical market correction, those are among the hardest hit stocks.
Chinese ADRs, which are super volatile in general, continue to show relative strength. Again, this is usually among the most pressured group during corrections. Not this time.
Quite a few high-beta, momentum stocks are holding well, as well. A quick look at my SL50 momentum list shows numerous breakouts this week – GIMO, ANET, LOGM, FNSR, ZLTQ, etc. Those types of stocks tend to underperform during corrections.
All of the above makes me consider the current correction just a 5-8% garden variety pullback within a bull market. Maybe, it is too early to judge and fear will accelerate when prices go lower. No one really knows. Just thinking out loud and sharing a few observations.
The selloff last Friday brought back some volatility into the market. So far today, we are seeing a pretty strong bounce, but not impressive enough to change the overall technical picture. There are three main scenarios for the stock market in the next few weeks, listed in terms of probability:
1. SPY and QQQ enter into a wide, choppy range. Breakouts won’t work as well in this environment compared to the last 2-3 months. Mean-reversion trades will have an improved likelihood of success.
2. After a brief consolidation below their 50-day moving average, SPY and QQQ continue lower and test 210 and 110 respectively. Short-term volatility futures could go in backwardation under this scenario.
3. Quick V-shaped recovery to new all-time highs. This seems the least likely, but it is good to have an open mind and more importantly, keep a watchlist with stocks that have held well during this minor pullback. Those stocks are the new leaders.
