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What works and what doesn’t
Follow trends, keep it simple, and ignore the myths
This week I’ll try something different. Instead of reviewing the market, we’ll look at some strategies that work in trading as well as a few prevailing myths.
1. Bases within uptrends
Typically, bases resolve in the direction of the primary trend. If something is in an uptrend, chances are that the ticker will continue to rise. Aligning ourselves with the trend makes our life a lot easier.
Example 1: In Feb, I tweeted how TOU was one of the cleanest and strongest uptrends in the oil sector. After this breakout, TOU is now up 50%:
Example 2: In April, I wrote how waste removal stocks were in clean uptrends. WM and RSG weekly charts made breakouts recently. Here’s WM monthly – a beauty:
Example 3: A month ago, when everyone was convinced that a recession was coming and stocks were headed lower, I tweeted this CP weekly chart basing in a strong uptrend. It’s now rallied 14% and on the verge of a breakout. And like WM, the monthly chart for CP is fantastic.
Example 4: Last week, we looked at how DGII, SWIR, and ENPH were winning trades. They were identified as leaders 6 weeks prior to making big upside moves.
In the case of SWIR, it was being acquired by SMTC. We didn’t need to know this information before it was released. The price action was telling us to get interested in SWIR and avoid SMTC well in advance of the news!
The converse is also true. The weakest downtrends continue to frustrate longs. We’ve been seeing that with MJ and SOCL ETFs.
2. Major base retests
Typically, these are fantastic dip-buying opportunities.
I’ve been discussing how earlier this summer, a lot of diverse market segments retested multi-year support levels before the strong rally we’re witnessing.
Just look at all the base retests that held in the materials space:
3. Other stuff that works:
Following the smart money (using 13F filings, Form 4, CoT, etc).
Uncrowded trades. Many of my winners came from niche areas that few were discussing: farmland (Q4 last year), palladium (Q1 this year), IoT, etc.
Favoring companies that return capital vs. destroy capital. I discussed this a few weeks back: Link. For example: In the gold space, gold royalty companies have been in long-term uptrends while the broader gold mining sector has done essentially nothing for the past 4 decades.
What doesn’t work
There’s many traps in trading. I made the graphic below 2 years ago:
There’s also a long list of market myths.
Every May, I’ll see someone tweet “Sell in May and go away.” There’s studies that show investing in the market only between Nov 1st and April 31st is a good idea. But that’s not a viable strategy as the past 5 years have shown:
It might be funny to see some media personality always get the market wrong. But fading them is not a good strategy:
“NAAIM is a good contrarian indicator.” Except, if you copied their allocations, you got a better Sharpe Ratio vs. a 70/30 stock/bond portfolio. I discussed this in more detail near the end of this blog post from March: link.
Assuming correlations remain static is another pitfall. Lately bond yields and oil have been moving inversely to stocks. But there’s often been long periods where they moved positively with stocks (eg. oil used to be considered a “risk-on” gauge while bonds often were a “flight to safety” when stocks have been weak).
And please, stop trying to piece together the macro puzzle to put on a trade:
In developing trading strategies, there’s 3 things to remember.
First, always question why a certain edge works:
Following ‘smart money’ works because we’re copying sophisticated players that have access to a lot more data, tools, and manpower than we possibly can have. They make calculated decisions rather than emotional ones.
Following trends works because it’s a form of following institutions, as their trading activity leaves footprints in the price. Trends also persist because, like star athletes, strong countries and quality businesses continue to dominate for a while. The business cycle and monetary policy is also gradual, creating trends.
Astrology is NOT an edge that has reasonable basis!
Second, the way you capitalize on an edge should be simple:
Few parameters in a quant model
Horizontal lines on a price chart
Simplicity reduces biases (people will draw diagonal lines to fit their bearish or bullish bias) and data mining (people will use fancy indicators with fine-tuned parameters that give amazing backtest results, only to fail in real-time).
Finally, use longer timeframes (eg. weekly charts instead of intraday). This reduces noise and lets you see the big picture, thereby reducing whipsaws & trading.
That’s all for this week!
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Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.