The Other Side of the Trade

Whenever you enter a trade, there is somebody who wants to take the other side.  People forget that for every buyer there is a seller.  And it matters what type of person is on the other side. 

Let’s say you sell short a blue chip tech stock like AAPL.  Who is on the other side?  Most likely the person on the other side of the trade is an institutional investor, because for such a huge stock like AAPL, most of the end user volume is coming from funds managers or investment banks.   Sure you have the HFTs skimming profits, but they aren’t a long term factor. 

Now let’s say you short a low float, small cap stock that is up 100% on PR hype, or even a chat room pump.  There are so many of these kinds of stocks that I won’t even mention the name.  Basically your typical pump and dump play.  Who is on the other side of that trade?   Probably retail investors.  There may be a few hedge funds and quant shops that specialize in short term trading on the other side,  but the majority of the volume will be retail.  

Who do you want on the other side of your trade?  Institutions are far from being great investors, but they are much better informed than retail investors.  Retail investors make a lot of mistakes, which become magnified when trading volatile stocks.  Here is a list of some of the most common retail mistakes:

1.  Chasing the latest hot stock, buying into a PR or chat room pump believing the hype.  
2.  Minimal knowledge of fundamentals, don’t read or understand the SEC filings.  
3.  Looking for fast, quick gains, playing on much shorter time frames.
4.  A good trade is  a trade.  A bad trade becomes an investment.  Holding on to losers and becoming bagholders after the pump.  
5.  Poor at risk management.  Not cutting losers, liable to get margin calls and blow up.

Compare this to the most common institutional investor mistakes:

1.  Herd behavior and group think, but on a much longer time frame than retail investors, which makes it tough to fade.
2.  Can’t take excess downside volatility, due to client/bank demands.  Often stop out of positions when they go against them, even if fundamentals of stock haven’t changed.

Retail investor mistakes are much more common and more fatal when they happen.  Trading is about taking advantage of opportunities.  Opportunity comes when the other side makes a mistake.   That is why its easier to make money trading small caps than big caps.   And definitely much easier than trading macro like stock indexes, bonds, and FX. 

In macro, its dominated by the institutions.  That is why its much harder to beat that game.  The biggest advantage of trading futures vs small cap stocks  is leverage.   The next biggest advantage is liquidity.  You can trade more size and get in and out much more easily without moving the price.

When retail investor numbers are low, like they were from 2008 to 2016, then its better to trade futures.  But when retail investor numbers are high, like it is right now, its better to trade small cap stocks.  

We made an all time high yesterday and quickly sold off intraday, and gapping up strongly again today.   I sold longs on Monday and have been on the sidelines, mainly focused on individual stocks.  I don't expect to do much unless we get a big move either way from current levels, either an overextension move higher towards SPX 3800, or a dip down to SPX 3620. 

SPAC Boom

When the ducks are quacking, Wall Street comes to feed them.  And they are happily feeding them.

That chart was made 3 weeks ago, showing 208 SPAC IPOs YTD, it is 248 now.  so 40 SPAC IPOs have come out during that time.  Those 3 weeks, had more SPAC IPOs than any year from 2009 to 2017!   That is an average of 1 SPAC IPO per trading day in 2020, with the vast majority coming in the 2nd half.  

And why are they excited to buy these IPOs?  Here is the IPO performance over the past 10 years vs. the S&P 500.  The outperformance in 2020 is 1999-esque. 

And these SPACs, with their "blank checks", have to buy something to justify their existence.  And when you have so many SPACs competing to buy up companies that are the most popular on Wall Street, that probably means one thing:  overpaying for a lot of horrible EV related companies.   The counterargument could be that they could just not find a suitable company to buy so they'll return the money to investors if they can't find anything worth it.  Are you kidding me?  They'll buy any two-bit EV company, even if its run out of a garage.   Just like in 1999, when you have a sector that is suddenly hot and in demand by investors, supply is created one way or the other.  Either through SPAC acquisitions (now) or IPOs (1999).  

The important thing to remember about an IPO boom is not the amount of supply created by the initial issuance of shares, but the torrent of lockup expirations that happen 90-180 days later, bringing out even more supply than the initial wave of shares.  

Eventually, the hot demand for these EV and ESG names ends up creating a lot of bad supply, as in overpriced, hyped up, and unprofitable concept stocks that always sound great when there is no pressure to be profitable because all the revenue is supposed to be generated 3 to 5 years in the future, when supposedly everyone will be buying EVs and dumping their gasoline/diesel powered cars in a firesale to used car dealers. 

This EV boom is in many ways more ridiculous that the dotcom boom in 1998-2000.  At least with the internet, it was actually a disruptive technology that had a huge effect on businesses.  But EVs?  Really?  Are people's lives really going to change because they have an electric car instead of an ordinary gas powered one?  With the internet, the imagination could run wild with all the possibilities, and yet, not that many companies benefited.  With something far less consequential as EVs, its hard to imagine it changing much of anything. 

Electrics cars are a solution seeking out a problem that doesn't exist.  Last time I checked, electricity was mainly generated by burning coal and natural gas, and those create greenhouse gases just like burning gasoline and diesel.  Energy efficiencies are similar when you consider that while battery powered cars are more efficient than internal combustion engines, a lot of energy is lost in the converting coal/natural gas/renewables into electricity.  And the additional electricity demand from EVs will be mostly coming from coal, which is the cheapest, most abundant, and dirtiest.  So no, its not going to have much of an effect on greenhouse gases.

The parallels with the dotcom boom and the EV boom are eerily similar.  After a long bull market, that lasted 18 years (1982-2000) and at least 12 years (2009-2021?), investors throw caution to the wind and start to speculate like crazy on the latest hot technology.  This ends up creating a lot of IPOs to supply the demand.  From 1998 to 2000, IPOs were considered guaranteed big money profits for those who could get in at the offering price, as the IPO pops on the first day were huge and IPOs outperformed the broader market. 

And the speculation eventually spilled over to biotech and semiconductors in the later stages of the bubble in early 2000.  Recently, biotech stocks have been on fire, especially the speculative small cap names that retail investors are heavily involved with.  Semiconductor stocks have also done very well this year, and have easily  outperformed the Nasdaq composite over the past 3 months: 

The only question is what stage of the bubble are we in, using the 1998-2000 comparison.  Well we are definitely past the December 1998 stage when internet stocks were the new stock market favorites and IPOs were just starting to ramp up hot and heavy.  But I don't think we are at the December 1999 stage when almost all the people I knew who were investing were over the top bullish, Fed was tightening, and economy was roaring at the time.  

The Rona has probably extended this bubble by 12+ months because it just resulted in a flood of liquidity, as M2 has gone parabolic, with the combination of a Fed spewing tons of liquidity which is being spent by the government in the form of monster stimulus packages.  So I think we're probably in the middle of 1999 stage of this bubble, which probably means that there is still another 6 to 9 more months of this craziness before we hit the peak.  That timing coincides with the 180 day lockup expiration supply that should all come around the summer/fall of next year.  It should also coincide with the peak of the vaccine distribution and opening up of the economy, which will bring a euphoria of economic optimism along with a very overextended stock market.  

The crowd is already quite optimistic as it is, but when most of the Rona worries go to the rear view mirror, and investors start to talk more about pent up demand and excess savings, that would probably result in the irrational exuberance that would be the bell ringing at the top.  Until then, bulls have the edge. 

The Bull Case

I am long term bearish on the stock market, but there are a few things that are favorable for longs.  

1. Money supply growth.  This is the biggest positive for the bulls, and it is unlike any rate of M2 growth when the stock market is at an all time high.  Usually, when stocks are at all time highs, the Fed is not doing a lot of QE and signaling that it will stay at zero rates for years.  From March to June, M2 was growing at a 65% annual rate, and while it is slowed down from June to December to a 14% annual rate, that is still very high, higher than anytime from 2010 to 2019.  When money supply grows much faster than the demand for goods and services, it goes to asset markets, the big 3:  real estate, stocks, and bonds.  If the supply of those 3 don't go up enough to meet the demand, then prices have to go up, regardless of valuations.  

2. Monopolies and oligopolies.  Over the past 40 years, competition for almost all industries has gone down and profit margins have gone up.  Nothing from the US government is signaling a change in policy.  There is no desire by politicians to do anything to hurt the stock market, which means they won't want to break up monopolies for fear of hurting the SPX.  Which leads to number 3.

3.  Fed and the government want a higher stock market.  It is clear now that the Fed has thrown away any fake concerns about asset bubbles.  They don't care about financial stability.  Powell tried to fight the stock market and he took the loss when he caved big time in January 2019.  Since then, Powell has followed the standard Fed playbook of acting like turtles and doing nothing when bubbles are getting bigger, and acting like rabbits and immediately bringing out the bazooka at any sign of a weaker stock market and/or even a sniff of a weakening economy.  Powell now knows that he's only liked and given good reviews when the stock market is going up.  SPX is going up = good monetary policy.  SPX is going down = bad monetary policy.  So naturally he will do anything to make the stock market go up.  

Note that I mentioned nothing about the Covid vaccine or the pent up demand for travel and services.  Those are positives for the real economy, not the asset market economy.  A lot of people confuse the two and that is the biggest reason for macro bets that go bad. 

Rona Part 2?

 Going into the end of the year, what else, but the Rona to provide the last bit of volatility for this crazy stock market.  You just had your casual 120 SPX drop from Globex open to the premarket lows, on nothing more than some fears of a Rona variant that is causing a little panic out in Europe, again  (remember late October Europe 2nd wave fears?).  And they agreed to the $900B stimulus deal.   And they also pumped the financials on Friday after hours on the Fed pouring more gasoline on the inferno by letting the banks buyback stock.  

So a classic bad news following good news situation, where they aggressively sold the positive news, and Europe joined the sell party thanks to Rona fears again and you get a panicky plunge from 3680 to under 3600 in just over an hour.  

This is NOT your typical post crisis bull market, it is a hyper volatile chase for performance, as the hedge funds are at 99 percentile net long exposure along with mom and pop pouring money into equity funds after the all clear post election.  

So how to play this?  With Christmas and New Year's just around the corner, any post opex hangover that you see today will not last for long.  Those that want to sell size and reduce risk have probably already done so earlier in the month.  The yearly performance is strong, so its hard to get fund managers to de-risk in a panic over worries about being down on the year.  This looks like a decent buy the dip opportunity, with strong support below at SPX 3600, and above that, SPX 3630-3640 area.  Also, gold and bitcoin are strong, so you don't have much collateral damage here.  I did a little buying in the premarket and may buy more during the regular session.  Not looking to hold for long, maybe a few days to catch a relief bounce.  Will definitely sell before the end of the year.  

In an optimistic market, you get these occasional plunges lower to trigger all the sell stops from fast money longs, to cleanse the system, for the next move higher.  The first couple of dips are worth buying, when the dips start to become more common, it gets more and more dangerous buying the dip.  Right now, we're not at that danger zone.  The market still hasn't given enough opportunities for latecomer bulls to buy, so it should still be relatively safe to buy.  

It is interesting that they use computer jargon to describe these Rona mutations, they are calling this new virus a variant that is 70% more contagious.  At this point, the market is still expecting the vaccine to eliminate all future Rona fears so it will probably look past this little hiccup in the road to normalization.  Now if there was a problem with the vaccine showing serious side effects, that is a more serious issue, but this just looks like another Rona scare that eventually goes away and is quickly forgotten.

Leaning long today into next week.   With the renewed Rona fears, I like Nasdaq over SPX until year end.

Pump and Dumps in a Raging Bull Market

In a strong bull market, there are fewer opportunities in the index futures market.  When institutional investors are comfortable and have made a lot of profits, they trade much better than when they have been losing and are starting to feel the pain.  Much like a poker player usually playing better when he's winning than when he's losing, investors are similar.  It is psychological, because poker players, just like investors, don't like sitting on losses and want to make something happen to reverse their situation, and that means either playing too loose or aggressive.  For traders, its overtrading and betting too big to make up for losses quickly.

Even though the VIX is staying above 20, this isn't a typical high VIX market.  Since most institutional investors are sitting on large profits, they feel less of a need to trade, they sit on positions, and they make fewer irrational decisions based on fear.   When institutions make irrational decisions based on greed, those are harder to fade because they have staying power, and they are willing to hold on to positions for months at a time.   

That is where the big difference between retail investors and institutional investors comes in.  The retail investors in general, have a shorter time frame, and dominate the action in the small cap space.  Institutional investors, due to size constraints, usually avoid investing in small cap stocks.  

There is a clear dichotomy between how small cap stocks with a low percentage of institutional investors trade versus mid to large cap stocks with a high percentage of institutional investors.  Try this:  Go to finviz.com and do a screener on stocks that are up the most for the quarter.  Look at the stocks with almost no institutional ownership and compare them to the ones with some institutional ownership.  You will quickly see that the stocks up the most this quarter with some institutional ownership are much closer to the YTD highs (ex. CRIS, SOL, FPRX) than the ones that have almost no institutional ownership (ex. KXIN, SPI, CBAT), which have faded from their rallies much more quickly.  

This is extremely useful information for a strategy that involves shorting actively traded stocks that are up huge in a short amount of time.  A lot of these stocks up hundreds of percent in a few days are overreacting to some press release, a chat room pump, or most likely, involved in some hot sector which is latest fad in the market.  It was the Covid stocks back in April to July, the EV stocks from the summer to now, and biotech stocks starting from last week.  

Retail investors piling into the latest hot stock is the reason most of these stocks are up huge in a short amount of time.  But these retail investors don't stay for long, and if they do, they just become long term bagholders who eventually give up a few weeks later, sick of tying up their capital in a stock that is grinding lower.  So they instinctively sell quickly when the pump is over, learning from their past bagholding experiences, and their mass exodus is the reason for the dump.   

But not all pumps are dominated by retail.  Some have a lot of institutional investor involvement, and those are the stock rallies that have staying power, because these institutions have longer time frames and aren't looking to sell right after they buy.  

Institutions are also involved in pump and dumps, but they are on much longer time frames.  Just look at TSLA.  That may be the biggest pump and dump since the ones we saw in 1999-2000.  But it is a long term pump, so you can't really fade that, and expect a positive outcome, unless you are looking out over several months and years, and can withstand big drawdowns along the way. 

Some people may think it is odd to focus on shorting stocks during a raging bull market.  But they don't realize that it is only in a raging bull market when you get so many irrational moves higher in stocks that are unsustainable and quickly fade away.  It is only in these type of markets do you see mass retail investor participation in small cap stock speculation which create so many short term pump and dump situations. 

And it is harder to pick stocks that will explode higher, even in a bull market, but with shorting these pumps, you are already selecting the ones that are ripe to move back lower.  It is about probabilities and shorting these small cap stocks offer high winning percentages with big wins.  But there is one big downside to this strategy.  The black swan.  Some of these stocks will make insane moves that defy gravity, at least for a few days.  Causing giant short squeezes which are exacerbated by predatory algos looking to force short sellers to liquidate their positions.  A few examples:   AQXP, KBIO in 2015, DRYS in 2017, UONE, KODK, SPI, GLSI in 2020.  There are many more which I've forgotten about. 

So like a lot of trading strategies, the high winning percentage strategies are the ones that are usually short gamma.  Shorting small cap pumps is basically a short gamma strategy, as these stocks can sometimes go up thousands of percent before the eventual dump.  So unless one can manage risk and position size properly, its not a long term winning strategy, due to the potential blowup factor.   I would only recommend using only a portion of one's capital for this strategy, as 1. risky with black swan risk and 2. don't scale up well as most of these pump and dump stocks have low floats. 

Overall market is acting like its 1999, slow grind higher with dips quickly bought, rampant stock speculation, and optimism staying high.   Based on the time of year, starting from mid December, its really a no shorting time period because you rarely get any meaningful selloffs, and the risk reward is poor for shorting the indices.  So I will probably not be trading from the short side in SPX for the next 2 weeks.  All the action these days is in individual stocks.

Walking the Tightrope

Throughout my trading career, I’ve had a few close calls.  Not just losing a lot of money, but real danger of losing it all and going negative.  

I was trading only stocks at the time, and I only had one strategy.  Shorting pump and dumps.  It was a high percentage strategy, winning percentage was over 90%.  And the wins were not small, around 10-20% on average, over 1 to 2 days. 

Winning percentage over 90%,  aggressively using margin, and 10-20% average gains add up quickly.   I didn’t know why more traders weren’t doing what I was doing.  There were some, and most of them were making a good living off of it, but most of the traders out there were long, and short sellers were viewed negatively.  Just looking at the Yahoo message boards at the time, you could tell.  Most of these retail traders/investors were looking for the next big move higher, not lower.  

It seems like shorting is just not natural for most traders, rooting for a stock to go down to make money.  Its like betting on the don’t pass line in craps.  Most craps bettors bet the pass line.

When I was trading back in my earlier years, I was reckless.  If I was winning most of the time, why not make as much as possible and bet big?  I had no money management, no risk controls.  It was a balls to the wall type of trading, and it led to spectacular rises and even more spectacular crashes.

Going all in was not something that I did only for the best setups, I did it almost all the time.  If only had I known back then how extreme volatility in the account is bad for long term returns, I wouldn’t have bet so big.  And probably would have a lot more money now. I wrote about this several years ago.  I didn’t even think about the Kelly criterion, about the probability of losing my bet.  Or even the thought of having cash as providing optionality for averaging into a bet at a better opportunity if the move goes against me.

In February 2000, I shorted a multi day runner called Metrocall (MCLL), a paging company that was suddenly now a wireless internet play.   Investors stretching their imagination to pump up a stock.  It was common back then.   It went from around $1 to over $5 in a few days and came up on my scans.  I knew it was a dinosaur paging company that was eventually doomed so I started shorting the stock around $5.25, with plans to add more if went higher.  It was a crazy time, moves got wild, so even the aggressive short seller I was didn’t go all in right away.   The next day  the stock gapped up and started trading in the 7s, and I decided to add more, going almost all in, giving myself some room to weather a spike towards 10 if it happened, but I expected this to be the final pump day and expected a dump coming very soon.  It grinded higher into the close that day, closing near 10, putting me in a margin call.   I was in the middle of the maelstrom, and all I knew was just to hang on and hope it didn’t go much higher.  

The next day, I was in a full blown crisis situation.  MCLL gapped up above $11, and I was all in.  I knew it was eventually going to go way below my average short price, I just had to weather the storm.  The short squeeze and momentum daytraders piling into the stock took the stock all the way to $13 in the morning, and now my account had a negative balance!  I had blown up completely.

I was expecting a phone call or an email from my broker about the margin call and my negative account balance but they didn’t contact me.  The stock went over $14, making my account balance even more negative, and I was getting bigger and bigger into debt to my broker.  The volume and price action was frantic on MCLL, but it eventually settled down as the stock ran out of momentum and fell back down to close around $11.  I breathed a huge sigh of relief as it looked like I dodged a huge bullet.

I was going to get another margin call, but at least I had 2 more trading days for the stock to go down so I could hold on to the position.  I had no other money outside of that brokerage account so sending in funds was not an option.

Back in those days, most online brokers used primitive end of day risk management systems, and you actually had 3 full trading days to meet your margin call.  You could push the boundaries of using margin and even hold on to positions despite losing a lot and becoming deeply under margined.  They only liquidated you after the 3 days were up and you were still under a margin call.

Luckily, MCLL gapped down the next day under $10, and the selloff that I expected to play out 2 days before finally happened, and I covered about half at a more manageable loss and kept the rest and covered a few days later near break even. 

If I had put on the same trade in 2020, I would have been liquidated on the way up near the peak and my account would have been in tatters.  Or worse  they discover it late after my account went negative equity and liquidated me.  That actually happened a few years later, although that’s another story for another day.

That kind of all in trading eventually caught up with me and I did blow up a year later, and again and again after that.  I still have to fight those outlier black swans every now and then, even though I don’t ever go all in on my capital on one trade anymore.

We are getting the big gap up off of the small down day on Friday, on no particular news, or is it Mutual Fund (now ETF?) Monday?  I did cover my small short on Friday for a small gain, as I wasn’t super confident about the trade and took the gift of a dip to cover.   No edge at these levels in SPX, just focusing on individual stocks where the action is these days.

A Full Blown Casino

The daytraders are having a field day with this market.  They are pumping and dumping tickers left and right.  It was EV stocks in November, and the flavor of the month in December is biotech.  It only takes a few hot runners going up hundreds and even thousands of percent in a day to get the retail punters super excited about a sector.  How about this chart for a spike to the moon?  Just a casual 2400% move higher in one day. 

These are the type of moves that get daytraders coming back for more, trying to find the next $GLSI.  Today, they have crowded into another small cap biotech, IMMP, up a casual 180% as I write.  

You had craziness like this in 1999 and 2000, with one sector being hot, and then suddenly, out of the blue, another sector becomes the one that all the traders chase after.  In early 2000, suddenly biotech became the hottest sector on the planet for a brief couple of months.  In 2000, it was from internet stocks to biotech stocks.  It is eery how similar the baton is being passed from the long running hot EV stocks to the suddenly hot biotech names.  

There are no fundamental reasons for the rise of biotech.  It is all based on price action and momentum, and hoping to find the next big mover going up hundreds of percent in a day.  It is lotto fever in the stock market.  That is why so many retail investors are buying calls to try to hit that home run, that one trade that makes several hundred percent in a week.  

It is dangerous to play in these waters, especially if you are playing the hottest names.  I am sure quite a few traders blew up on GLSI, both on the short side on the parabolic move higher, and then halt fest move lower from over 150 to 50 in an hour.  

The quant funds with their algos are all over these stocks, manufacturing short squeezes, and then panic dumps from the longs on the other side.  It is casino capitalism.  A bull market that seems to have lasted forever has finally sucked in the retail crowd.  A 1999-2000 deja vu moment in time, where optimism is through the roof, volatility rises, and crazy moves happen.  

This is an unstable state of the market.  This level of speculation usually doesn't last long.  Dumb short term money is driving the markets now.  The smart money don't create these crazy moves in stocks.  The dumb money does.  Eventually, money transfers from the dumb money to the smart money.  When the dumb money goes back to being just a bit player in the stock market, without the ammo to create these wild, crazy charts, then we'll return to your staid, boring 2012 to 2017 type of market.  Until then, make hay while the sun is shining.  

Golden Age for Pump and Dumps

Don't take these markets for granted.  Retail investors won't be staying around at this kind of volume forever.  Back when I was trading in 1999, I thought those kind of crazy markets would stay around for longer than it actually did.  By late 2000, most of the crazy moves in individual stocks was gone, as retail investors were getting pummeled in their tech stocks and risk appetite dropped off a cliff.  

Back in the old days, only the crappiest of companies that couldn't easily get through the IPO process resorted to being bought out by SPACs.  Now, SPACs are all the rage, a quick way to raise money to buy private companies and take them public.  Of course, the ones who are upstream get the easy, almost risk free money, while the ones downstream, the retail investors and ordinary mutual funds absorb the risk of buying two bit companies at absurd valuations.  

After a long bull market, what was once avoided are now embraced.  Profitless companies going up on Wall Street hype are the hottest stocks.  TSLA in 2020 is the YHOO of 1999.  The internet stocks of 1999 are the EV stocks of 2020.  The big difference is that unlike in 1999, the insiders of these junk small cap companies weren't doing secondary offerings and filing huge shelf statements to dump as much stock as quickly as possible.  The float basically stayed the same and most of these companies didn't fully utilize the pumped up stock prices to raise a bunch of cash.  It made for some unbelievable short squeezes and momentum runs that didn't get hit with a bunch of company issued supply. These days, the insiders of these small caps have gotten wiser, and issue as much stock as they can into the higher prices and better liquidity that daytraders and momo traders provide.  

To name just a few companies that have issued tons of stock after retail traders pumped up their stock prices:  NNDM, KNDI, XPEV, SOLO, AYRO, IDEX, SRNE, IBIO, HTBX.  

All of these stock offerings after PR pumps or even chat room pumps just give the short side that much extra edge.  Especially for those holding swing and longer term positions.  The downside of holding short positions in these pump and dumps is that the short borrow interest rates are usually extremely high, anywhere from 50 to over 200% annualized.  A stock could go down 10% in a month and if the short borrow rate is 120%, the short position in the stock would just break even.  Back in 1999, there was no short borrow fee, so it was a great time to just hold long term short positions and ride down the pump and dump plays.  But with so many hedge funds shorting and clearing firms trying to profit off of their customers, these firms are charging some ridiculously high short borrow rates to just hold a short position in a lot of these junky names.  

 But it is these same hedge funds that are the willing buyers of discounted stock in these stock offerings that a lot of these pump and dump companies utilize to raise cash.  So there are pros and cons from having so many hedge funds out there.  

As for stock indices and bonds, its a tough game right now.  When the SPX grinds higher and makes new highs, its tough to chase and go long, but also usually not a great time to try to fade the trend because its not easy to short the tops.  And the tops usually last longer than the bottoms, so there is a smaller time window of profitability for short positions, even if you do get close to shorting the top.  Still have a small short SPX position, but not looking to get aggressive, and willing to take a 2% pullback and look to cover there.  

Stimulus S.O.S.

 Here we go again.  Yesterday, the politicians had to throw in their word on a fiscal stimulus package before year end, and now the market is floating higher on stimulus hopes.  S.O.S.  Of course that is on top of the continuous vaccine pumps that we've had for the past 3 weeks.  Don't know if the stimulus will actually get passed, but I don't think it really matters, the market is expecting a stimulus bill passed sometime early next year when Biden gets in, so its not really a big deal whether it gets passed or not. 

Looking back at 2020, it was just a giant bear trap that killed the bears.  2021 just may be the giant bull trap that kills the bulls.  There are clues in the market that tell you that this rally is a bit different than those in the past.  Normally, after a capitulation low, and a 5 week rally to an all time high, the VIX goes down way below 20, and usually below 15.  Instead, the VIX has stayed above 20, even with realized vol much lower than implied vol.  You really haven't seen this kind of VIX action since the late 1990s/2000.  

You also haven't seen the same kind of dispersion between the Nasdaq and the Russell 2000 since the late 90s when like this year, Nasdaq was the strongest and the Russell 2000 was the weakest.  Only in the very late stages of the bubble in early 2000 did the Russell 2000 finally start to keep up with the Nasdaq and even outperform.  

That is what is happening now.  They say that strong breadth is positively correlated with future stock returns.  Yes, if coming off a bear market and or deep correction when valuations are not expensive.  Right now, we are at extremes of overvaluation in stock market history, so strong breadth is more of a sign of a euphoric topping phase to these eyes.  Time will tell, but the excessive money printing doesn't always go to the stock market, but can go to the real estate market, or even go to the bond market.  

Most of the excess money supply in Europe has gone to the real estate and bond markets, as the stock market has gone nowhere for the last 13 years there, while real estate prices have risen strongly. 

It has been 5 weeks since the October 30 bottom in SPX, which is about your standard 4-5 week rally off a capitulation low, before you start getting into more choppy trading and more range bound prices.  Lot of "good news" lately, and optimism seems a bit overdone here, so I took a small SPX short yesterday morning to try to pick the top of the range.  Not a great setup, but ok for a small position, just to keep me interested in following the indices and ready when better things show up.  Still mostly focused on individual stocks, where the action has cooled off a bit, but still some opportunities there.

Classic 3 Day Parabola Pattern

 When trading based mainly off of pattern recognition, with a foundation of fundamental analysis, there is an optimal amount of movement, or craziness.  Too little movement and not many opportunities show up, too much movement and you get into the danger zone, the edge of the cliff where the equity curve can drop off the edge like the head of a sperm whale, when moves go further than what was imagined.  

For example, the Nasdaq in 1998 and 1999 had the right amount of craziness and movement, but the Nasdaq from December 1999 to March 2000 was a parabolic move that blew up mean reversion strategies and short sellers along with it.  

Right now, in late 2020, we are near the maximum range for optimal price movement for trading the short side of parabolic moves in individual stocks.  A little bit more craziness, an extra day of parabolic price increases, a few more bold retail traders, and you push the needle past optimal movement to the stop loss zone and max pain regions.  

The trade in PLTR last week is a perfect example of the optimal level of craziness for shorting.

You had the classic 3 day parabolic move up, with day 3 bringing on huge volume with lots of excitement among retail.  If you look at the reddit wallstreetbets forum, you can get a great sense of what the fast money is chasing.  It is a great source of short ideas.

Another one, which I missed, just because MRNA is not really a classic daytrader stock, until the last 2 days, when its acted like one.  So totally missed the boat there, but if I was paying attention, I would have gone in short yesterday morning.  It was almost a carbon copy of the PLTR trade from last week.  Huge opportunity missed there.  

Despite what looks like easy pickings in the above 2 cases, sometimes you don't get such clean price patterns and the associated euphoria near the top.  Sometimes the patterns can get extended out and overall, the upward price volatility during this bubble phase has to be respected.  Going all in short because a trading opportunity would win big 90% of the time, leaves one exposed to the 10% probability of a black swan happening, with prices going beyond what was planned for.  

I don't use hard stops, and most strategies that use hard stops have deteriorating performance, but that doesn't mean there are points in a price spike where something unusual is happening and its better to cut losses, to avoid a possible downward spiral of forced short covering and further price squeezes.  But the art of short selling is knowing when to cut the loss to avoid blowing up, and knowing when to just hang on through the maelstrom to get to the other side, when the storm clouds clear up.   And avoid covering near the top.  

Overall market looking toppy yesterday, with lots of call volume relative to puts, and also weak bond market which gives index shorts a higher probability.  May get in a little short today or tomorrow.