Morning Market Thoughts
Good morning. It’s looking like yesterday’s breakout has a bit of follow through this morning. Breakouts are like that — they’ll go through a process of slowly bringing in new money as more and more investors/traders start to believe that they are missing out. But breakouts get started by large traders. They tend to be buying before the breakout — though many are also brought into the market after the initial breakout because they have no choice. They buy to avoid underperformance. But ultimately, this initial move is going to end and stocks will come back down. Hence, the “Three Day Rule”:Day One: The smart money buys on the first day, thus being the catalyst for a big move. The move gets a lot of attention from the financial media.
Day Two: The “semi-smart” money buys on the second day because they see what’s happening and are aggressive. They don’t wait to “make sure the move is real.” They understand risk management and put their money to work. (By the way, this focus on risk management is the reason why some breakouts will fail and ultimately quickly reverse. If there is insufficient follow through via aggressive buying to keep the stock (or market) moving higher into the new breakout, the move stalls. At that point, this Day Two (i.e., semi-smart) money will cease buying and may even sell. That perpetuates the reversal and creates a failed breakout.)
Day Three: This is the “not-so-smart” money — having seen the move, this group of traders was inactive. They were waiting for more. They’d been burned too many times by buying at the top, so they wait for confirmation that it’s safe to buy. So by Day Three, they are convinced that it’s OK to buy. And predictably, because they are the slowest, smallest traders, all the real buying has been accomplished. These latecomers are actually buying stock from the traders that were in at lower levels and are now taking profits. So, once again, the Day Three money has bought the top. Oops.
This “Three Day Rule” applies as a “template” for all of your trading activity. It can be a three day rule, a 3 week rule, or a 3 month rule, etc. It can apply to large pattern breakouts like we are seeing in the S&P, or to volatility squeezes that start to pop (hence, my “Phase 1,2,3” analysis. It’s the same principle!) And this goes further, The Elliot Wave Theory (more of a religion than a method of analysis) is also based on waves — and there are three of them…and then three waves within each wave, and then three more, etc. In trading, the rule of threes is everywhere. Trading outcome — three possibilities: you make money, you break even, you lose money. The stock, and your risk management, dictates how pronounced the outcome really is…but there are only three possibilities.
The timing isn’t as important as the dynamic — you’ve just got to realize that stocks move in waves because not all traders are alike. If you strive to manage your risk rather than pouncing on a move with everything you’ve got, then you’ll start being more comfortable getting into the Day Two crowd because the risks are less. You’re not making a BIG decision. Rather, you are seeing a move with a defined risk, and taking prudent action by opening a small position that gets you going; gets you “involved.” If you start small, you’ll find it easier to act sooner.
This concept that I am discussing is an essential concept for you to know. And if you apply it diligently and consistently, you will soon forget all about it because you are just doing it automatically. Like brushing your teeth. You’ve been doing it so long (hopefully) that you have an unconscious process. You don’t miss any teeth, but you don’t think about it either. You are not brushing with intent; you are brushing out of habit. Good trading is about habit.
Develop good habits and you’ll develop into a good trader. And good traders last. Poor traders move on to another line of work.
A couple of random thoughts:
What do I hear when I first turn on CNBC this morning? The hosts talking about Pokemon. Seriously, I have no idea what Pokemon looks like because I don’t play video games (not even Call of Duty). But this fixation on a phone app that entices people to get completely lost in their 5-1/2 inch screen is kind of sad. A while back I read a news article about a hapless individual who walked right off a cliff down in San Diego and fell to his death — because he was fixated on his iPhone and was not aware of the absence of earth in front of him. Not a great way to go out — I can only imagine what the eulogy was at the funeral service. Don’t be that guy. Nor do you want to be the guy who was watching Harry Potter while his Tesla tried to disprove Newton’s Law about two bodies not being able to occupy the same space at the same time. He didn’t get to finish the movie, and was unsuccessful in his challenge of the universal application of Newton’s Law. Don’t be that guy either.
“Keep your eyes on the road and your hands on the wheel.” Jim Morrison (who died of a drug overdose…surely because Pokemon hadn’t been invented yet). This applies to trading as well as driving.
Speaking of Tesla. Tesla announced that they are going to produce an even lower priced model of their Model X Crossover — starts at about $79,000. The catch? The range is lower. I seriously doubt that a $9,000 reduction in price (in an environment when car loans are nearly free) is going to entice many buyers. The typical buyer wants to drive their car. If they have to keep looking for charging stations all the time, they are driving less and sitting at the charging station playing Pokemon more. Simply put, I doubt a cheaper car that doesn’t travel very far is going to be a winner. I had one of those when I was a kid. It was called “Hot Wheels”. Also, isn’t $70,000 a lot to pay for a car? I haven’t bought one in a while, but that seems like a lot of money.
Anyway, I’ve gone on far longer than I anticipated, but that’s what happens when I put a couple of shots of espresso in my first cup of coffee.
See you in the forum.
–Dan
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