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Are You Trying To Pick Tops?

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I went out on a limb during Monday morning’s Market Forecast video by saying that the January Break started with the poor jobs report Friday. It was my first contribution to the daily video, and since it wasn’t a very good call, hopefully it won’t be my last. In hindsight, coming out swinging on my first day telling people to short the S&P probably wasn’t the best way to kick things off.

On a quiet news day, a thin-to-win type of trading environment took over, and before the noon hour struck (Central Time) my early call for a pullback was turned to dust. Even though the S&P 500 futures didn't print a new high until near the close, I don’t feel vindicated in the least bit. I know I’m toast on this one. The old adage that says you should “never short a quiet market” rings as true today as the first day it was written.

 

There’s a lot of information coming out this week, with Q4 bank earnings taking center stage. Banks are looking like they wrapped up another record year, so anything less than extraordinary earnings reports could possibly be viewed as negative.

In the same breath, the last few years have shown us, beyond a shadow of a doubt, that the market has a tendency to take bad information and make good of it. This trend will most likely continue, but my overall feeling is still that stocks are stretched a little thin right now, and taking a small step back to recharge will be good for the long-term rally.


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The Problem with Picking Tops

Picking tops is a lot different than picking bottoms. When trying to pick a bottom, your overall risk is inherently defined. The asset or derivative your trading cant go below zero. Noted, you probably don’t have enough margin in your account to ride out a break to the absolute bottom, but at least you know where the market will eventually have to stop when it starts going lower.

The inverse is not true when it comes to picking tops. Inherent risk is not defined. The asset or derivative you are trading has an infinite amount of upside potential. This means you’re exposed to unlimited risk, and it’s the main reason for increased short selling margin.

If you’re not familiar with this subject, a simple Google search will introduce you to the world of trading tops and bottoms. There are literally thousands of trade advisors out there with their own techniques, and depending on what time frames you’re trading, there are typically multiple setups every day. So, it’s an enticing option for day traders and scalpers alike.

My call for a pullback was based solely on fundamentals. Seasonal tendencies and historical data suggest the probability of a pullback in January is high. I’m not looking at levels or specific prices, just an overall tendency. That in itself makes managing risk much more difficult. Just like with every other trade setup, you should know where you’re getting out before you get in. 

The proper exit for this type of trade would be a new high, so if you’re trading a smaller account, this might not be the setup for you. 

Always Trade For Tomorrow

These types of trades should be very mechanical with pre-defined risk. Keeping emotion out of it is key. Selling a new high just so you can tell your buddies you picked the top is not the best way to go about this. If you don’t have a reason to be in a trade, then you probably shouldn’t be in the trade.

You should always be aware of the market environment you’re trading in. Is there news coming out, are you in the middle of a trend day? Recognizing what’s going on can stop you from putting on a series of losing failed top trades. It’s good practice to think twice before jumping off the cliff!

One of the hardest things for a trader to learn is moving on from a losing trade. The reality is, 6 months from now you won’t even remember this trade, so accept the loss and move on to the next trade.

As always, when trying to fade this rally, silly as that sounds, proper risk management is a top priority. Cut back your position size. Keep your stops tight, and don’t ever adjust them, no matter how strong the urge is. The market will tell you when you’re wrong; listen to it.

Posted by John D. on January 13, 2020
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