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Recently I received an email from a follower asking me what to do with his $NFLX holdings, on which he is down 40%. I am not going to mention his name as it would be inappropriate, but I am going to share my response as it could be useful to other people in similar situation. I like to receive emails and I always try to answer to the best of my knowledge:

Buying broken momentum stocks is not a sound approach, unless you are trying to bankrupt yourself.

First of all, it is very dangerous to own momentum stocks on the other side of the mountain. When the trends is over and a stock is trading below its declining 50dma, you are playing with fire when you go long.

Second, I’d suggest you to never average down – start with a small position and wait to be proven right, before you add.

Third, when you buy, assume that you could be wrong and always have an exit strategy. You can’t expect that you will always be right. No one is.

Also take into account opportunity cost. While you are waiting to be proven right (it might not even happen), there will be many other stocks that will provide better opportunities. Holding to a losing stock and hoping for it to bounce is like holding to a merchandise that no one wants (the market clearing price is not higher)

Regarding NFLX – it depends on your trading horizon. I don’t know the future, no one does. All I know is that currently the stock is in a downtrend on a daily and weekly time frame, meaning that I could not consider it on the long side for something more than a scalp on a 30min time frame.

I realize that you are down a lot on your NFLX holdings and you are not willing to sell now, because you would realize a loss. Guess what, you already have the loss. A simple question, you should ask yourself: is NFLX the best stock you could buy right now on the long side and why. From my perspective, it isn’t. Even if it rallies in the next few weeks or months, what are the guarantees that it will outperform many other names. There are better alternatives.

Take care,

The market averages have been in a wide range for the past 2 months. The same could be implied for many  stocks for the simple reason that during periods of heightened volatility, correlations approximate +1.00.

At some point, this range will be broken decisively and left behind. We thought that this moment was last week, when $SPY made new lows for the year, but the market reversed higher and the range survived. A few days later and $SPY is approaching the upper limit of its range. Will it matter this time again?

Most market participants have been lately conditioned to expect mean reversion from extreme readings. And by conditioned, I mean rewarded. I also fell victim to mean-reversion bias today, trying to short $SPY in the afternoon only to be stopped in the last 20min stampede.  I did not feel comfortable chasing stocks after several consecutive positive days. I did not feel comfortable shorting either, but did it nevertheless. I was wrong.

Everyone expect a reversal after a few strong days and this is exactly what makes the continuation of the current upward move quite possible. During market tipping points, the obvious rarely happens, the unexpected constantly occurs. Many of the weak hands capitulated during the breakdown last week. It is fair to say that the new owners of many stocks are currently acting from a position of strength and therefore are likely to defend their holdings this time.

There is a lot of cash sitting on the sidelines and waiting for the market averages to consolidate recent gains and new long setups to show up. There are not many such setups at this time, but a lot can happen in a week of sideways action.

Historically the 3rd year of the Presidential cycle has been very strong and positive in 21 of the past 22 years. I am not implying anything as 2011 has broken a ton of records so far.

The least expected scenario for Q4 is a strong market rally and this is exactly what could actually happen. My job is to remain open-minded and prepared for any scenario.