Oops a whipsaw

I tend to focus on risk management in these occasional observations I share.

My focus is on risk management because that’s my edge.

If I can direct and control my possibility of loss through tactical trading decisions, then I’m left to focus on the upside of profits.

I pinned that on my wall twenty years ago when I was testing asymmetric trading systems for asymmetric risk/reward and asymmetric investment returns.

As I intensely studied the mathematical expectation of trading systems, I concluded the downside drawdown is the part I have the potential to control.

If a position is trending down, I can exit, and reduce my exposure to zero.

I could also use exchange-traded options for defined risk. ie. if I buy a call option for $5 that’s all I can lose if the position doesn’t become profitable.

I could instead place a stop loss exit $5 below the entry price for a similar effect, but the position could gap down $10, and the loss would be larger than the limited call option would have been.

These are the kind of portfolio management decisions we get to choose from as investment portfolio managers.

I discuss this more in How is trend following with a stop loss optionality similar to a call option?

Our issue at hand today is the trendline whipsaw of the stock market index.

In Stock Market Resumes Downtrend I shared the observation the U.S. stock market as measured by the S&P 500 stock index, has trended down from a lower high.

Here’s the chart:

I went on to point out the stock index wasn’t yet oversold, and the number of stocks in the 500 in an uptrend was trending down.

Trend lines aren’t magic; they’re just a general trend guide.

I wasn’t seeing heavy selling pressure, so I thought “we’ll see.”

Here’s an update. See below for the context of the numbers.

  1. The downtrend line for the S&P 500 is now negated as the stock market has reversed back up and the index easily trended above the trendline and broke out to the upside. This will likely drive some to call the bear market over and suggest a new bull market has begun.
  2. Momentum, as measured by 14-day relative strength, indicates the SPX isn’t yet overbought at 62, and I’d only consider it so above 80. Read: there’s still room to run if it wants. There will be little resistance from velocity moving too far too fast.
  3. The percent of SPX 500 stocks trending above their 200-day moving averages is at 67%, so 33% of the stocks could still trend up, and 67% isn’t a level I consider resistance. That is, if it were at 80% it would indicate most stocks have already trended up, so the desire to buy may be getting exhausted.
  4. The average true range of the past 15 days shows a visual representation that realized volatility is declining. In fact, realized vol has declined to the August 2022 level.

I’ll stop there to keep this succinct.

The bottom line is the stock market was trending down, and it’s now reversed back up into a notable uptrend.

I started with observations of risk management because no indicator is ever perfect, they’ll all imperfect.

When every new moment is unique, and we’ve never been “here” before, anything can happen.

The best we can do is define the direction of the trend and follow it, until it reaches an extreme, or reverses down.

Ironically, as the realized volatility is now as low as it was in August 2022, that’s also when I shared Whipsaw and warned I have a hunch we’re going to hear the word “whipsaw” a lot in the coming months.

For the past year, we’ve survived and thrived through a prolonged bear market that may be much longer and deeper if the U.S. economy enters a recession.

Only time will tell if the U.S. is in a recession, or if we’ll instead see the soft landing our friends at Goldman Sachs expect.

But for now, the U.S. equities trend is back up again, and the Fed’s interest rate decision next week will likely be the driver of what happens next.

I expect 2023 to be a very challenging year for macro economics, and it’ll be fun to watch.

At Shell Capital, we just want to repeat another profitable year like last year, or better.

Mike Shell is the founder and Chief Investment Officer of Shell Capital Management, LLC, and the portfolio manager of ASYMMETRY® Managed Portfolios. Mike Shell and Shell Capital Management, LLC is a registered investment advisor focused on asymmetric risk-reward and absolute return strategies and provides investment advice and portfolio management only to clients with a signed and executed investment management agreement. The observations shared on this website are for general information only and should not be construed as investment advice to buy or sell any security. This information does not suggest in any way that any graph, chart, or formula offered can solely guide an investor as to which securities to buy or sell, or when to buy or sell them. Securities reflected are not intended to represent any client holdings or recommendations made by the firm. In the event any past specific recommendations are referred to inadvertently, a list of all recommendations made by the company within at least the prior one-year period may be furnished upon request. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities on the list. Any opinions expressed may change as subsequent conditions change. Please do not make any investment decisions based on such information, as it is not advice and is subject to change without notice. Investing involves risk, including the potential loss of principal an investor must be willing to bear. Past performance is no guarantee of future results. All information and data are deemed reliable but are not guaranteed and should be independently verified. The presence of this website on the Internet shall in no direct or indirect way raise an implication that Shell Capital Management, LLC is offering to sell or soliciting to sell advisory services to residents of any state in which the firm is not registered as an investment advisor. The views and opinions expressed in ASYMMETRY® Observations are those of the authors and do not necessarily reflect the position of Shell Capital Management, LLC. The use of this website is subject to its terms and conditions.