Weekly Update: Our Market Model Says “Wait”
Good evening, and welcome to this week’s edition of Stealth Trades!
Six months ago, we built a model.
It gauges the health of the stock market to identify bullish conditions where we should be buying and bearish conditions when we ought to remain cautious.
Right now, the latter is advised.
Above is a daily chart of the S&P 500 index. A green background designates a bullish market. This is when we want to be buying stocks.
Red, on the other hand, tells us that conditions are less than ideal. During these periods, we want to be less aggressive or flat.
The indicator is a combination of several inputs including price levels, market internals and breadth measurements.
And while no model is perfect, I am happy with the results.
Below is the same S&P 500 chart over the last five years:
It quickly went red 2 days into the COVID selloff. It also painted red for most of the 2022 bear market.
When conditions were favorable, however, it stayed green. This includes the 2020-2021 bull market as well as the strong rallies we experienced in mid-2023 and the last several months.
Does it pinpoint the precise top and bottom to the day? Of course not. Nothing does.
But it does what it is supposed to. It helps us tune out the noise and get an unbiased, scientific view of the landscape.
New traders are led to believe that top performers make money every week, every month.
It’s not true.
I have met some of the greatest traders of all time. In fact, I am currently in Las Vegas in a 2-day session with Tom Basso – a hedge fund manager featured in the Market Wizards book by Jack Schwager (look him up).
So, I can tell you with confidence, NONE of them are profitable each and every month.
Whatever your strategy, it will have periods of underperformance.
Value investors like Warren Buffett significantly underperformed the markets in the post-COVID bubble of 2020:
Momentum traders had a tough time in 2022 when the majority of rallies failed, and institutions were selling stocks hitting new highs.
Buy and hold investors all saw their accounts lose value in 2008. At the same time, short sellers and futures traders made a fortune in that volatility.
Whatever your strategy, you have to know its strengths and weaknesses. If your goal is significant outperformance, you must be willing to sit out when conditions are not ideal for you.
If I am tracking insider trades, I pay very little attention to my market health model. Why? Because insiders are experts at buying dips.
They have a long history of opportune buying near market lows – when my model is going to be painting bright red.
On the other hand, trading breakouts in high momentum stocks like we do in my Alpha Stocks service can be tough under bearish conditions.
So, when the model suggests taking caution like it does now, I tend to trade less and with smaller size.
Don’t misinterpret what I am saying. I am not suggesting this is the start of a long bear market. In all likelihood, it will be nothing more than a short-term pullback.
But after the hugely profitable period we experienced from November to April, the last thing I want to do is give back those hard-earned gains.
Unlike baseball, trading is not a game of called strikes. You can watch 100 pitches go by before taking a swing. The game starts and stops when YOU decide.
So wait for your moment. Demand ideal market conditions, perfect stock setups, whatever it is that gives your strategy an edge.
If you are selling options, you want the VIX above 20 and high premiums on those contracts. If you BUY options, your ideal environment is the opposite.
Wait for market conditions to be green for YOUR strategy.
And when they are… swing the damn bat.
Best wishes for your trading,
