Hysterical Thursday or whatever pundits are calling the May 6th stock price crash and recovery obviously has a lot people taking an in-depth look at what is happening with the market. Suddenly, we are hearing more stories from "old-school" traders and investors discussing the transition from a time when actual human beings controlled stock trading to the current environment where a complex system of hyper speed computers dictate whether prices rise or fall. Several media investigations have revealed the extent to which the market is influenced by the High Frequency Traders (HFTs) and similar rapid fire traders who have little or no interest in fundamentals and simply view stocks as abstract data. A research firm recently published a report indicating that as much as 60% of daily trading volume is generated by High Frequency Trading firms looking to exploit minute discrepancies between investment classes (e.g. when futures contracts fall out of synch with the related underlying stocks).
High Frequency Traders dominance of the trading business reminds people of movies similar to the "Matrix" where machines take over the universe and humans must fight for their very existence. The European debt crisis, BP oil gulf coast oil disaster, Iranian nuclear showdown, escalating conflict between North and South Korea, and other international headline news probably influenced investors psyche; however there is a train-of-thought that suggest these wall street computer models break down when unpredictable disasters overlap? Wall Street players, market regulators, the folks in Washington, and the media will be debating what happened on May 6th and what if anything should be done to help prevent a repeat. The one issue that is probably not in dispute is that most small investors will stay parked on the sideline. Generally retail investors sat back and did not participate in the stocks climb off the bear market lows, and it appeared they might be dipping their toes in the water again. Well, the water turned out to be freezing cold and they jumped back ashore until the water is safe.
At this point it is probably prudent for small investors in general and Couch Potato readers in particular to step back and wait for the market to signal the near-term trend. Most long positions initiated prior to the recent price correction probably suffered losses â€“ and of course this includes short put credit spreads that were part of an iron condor or other market neutral strategy. Just a month ago the Couch Potato Market Summary mentioned "... We seem to be getting a "short-squeeze" on most days as short sellers are forced to chase after prices that are bid up near market close. The major indexes have ended higher 11 of the last 12 days and most have recorded eight consecutive weekly gains. It has been quite a run for the bull and the bears must be pulling their hair out..." And a week later on April 27th stock prices broke down and signaled a change-of-sentiment was in the air. As indicated in the SPY daily chart down below, the current trend is definitely bearish. But the question is have stock prices found a bottom that will act as firm support? Stocks are way oversold and we need to see if last Friday's triple digit gain was the beginning of a relief bounce or simply a "dead cat" bounce as prices head toward new lows?
The SPY weekly chart down below might provide more clues on stocks near-term trend. Note how the weekly 50-week SMA is the support level for the recent market correction. But the recent bearish sentiment may be impacting the longer term charts and signaling a longer term decline.
Similar to the SPY charts, the DIA charts down below signal a bearish trend with oversold conditions and a possible support level.
The DIA weekly chart below confirms the 50-week SMA is support for the recent price correction, but stocks may be trending longer term bearish?
The May 16th Couch Potato Final Comment stated "...Right now downside volatility makes it extremely challenging to do market neutral trades. The key for us is to minimize losses and preserve capital until the environment is more conducive for our trading strategy..." If our agreed upon strategy is to minimize risk and the current market environment is not ideal for market neutral trading, then we must evaluate our choices. No trading strategy is successful in every market and after recent losses we need some profitable trades to get back on track.
The smart choice might be to leg into some low risk spreads, do a calendar spread, or open with a long call or put position and sell the short position after we figure out the trend. Typically the Couch Potato publishes iron condor trades and this worked because the stocks have supported market neutral trades even if we needed to do adjustments to make the trade work. But no one has adequately explained some of the recent price behavior. The bottom line is that volatility has returned with a vengeance and as everybody knows by now; market neutral trades do not like excessive volatility, especially if this happens after the trade has been on for a while. We will simply listen to what the market is saying and take whatever profitable, low risk trade is available, whether that is a long spread, short spread, etc.; sometimes the best trade is not to trade, but to exercise patience until we get a setup that fits our ordering rules.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.