Can't Beat the Races

"You can beat a horse race, but you can't beat the races." - How to Trade in Stocks, Jesse Livermore

I've tried to beat the races, and it is very hard to do.  Maybe only a few non HFT firms are capable of doing it, such as a Renaissance Technology.  It is hubris to think that you can predict short term moves accurately enough to make money everyday, against some of the smartest people on the planet.  Its possible if you are willing to play in less liquid niches where hedge funds and HFTs can't play in.  But if you are in big, liquid markets, you are playing a game that's tilted against you: having to pay the bid ask spread with adverse selection against players with better information.  

While its almost impossible to beat the races, it is possible to beat certain individual races if you are selective and know what to look for.  I have given up trying to make money every day.  I am not a salaryman.  I don't want to act like one.  The biggest mistakes are made when you try to catch every little move up and down, lose the forest for the trees, and miss the big move.  Or worse, go on tilt while losing and turn a small loser into a big loser.  That's another advantage of trading less.  You give yourself fewer chances to have a mental breakdown.  

The money is made in catching a couple of big moves a year, not in catching a lot of small moves.  The last trade I made, shorting SPX, was an example of a short term trade gone awry, holding too long, turning a smaller short term loser into a larger longer term loser.  Only those with great discipline, who are quick to cut losses should play in the short term trading game.  And even then, the odds are against you. 

Last Monday, I mentioned 2 scenarios where the SPX could go which would affect my view on the next 2-3 weeks.  They were the following:

SPX 5550 was the pivot.  

The first path:  If the SPX stays below 5550 for most of the next 3 weeks.  If the SPX trades mostly below 5550 and stays choppy in a 5350 to 5550 range, then another leg down is likely.  Under that scenario, the SPX retests the 5200 level, and possibly undercuts the lows of August 5.  

The second path:  If the SPX stays above 5550 for most of the next 3 weeks. If intraday volatility dies down with no moves below 5450 for the next 3 weeks, then you are looking at a grind higher into the FOMC meeting and the first rate cut of this cycle, possibly making new all time highs, with a pullback post September opex and in October to be mild, with the SPX bottoming above 5350.  

A week has passed, and the SPX traded above 5550 for all of last week.  In fact, we finished at a closing high for the week on Friday after the widely anticipated Jackson Hole speech.  So far, it looks likely the SPX will be following the second path, and grind higher into early September.  The SPX has shown immense strength since the August 5 bottom.  Its been a V bottom, and that usually happens in a bull market.  In most of these V bottoms, the market goes up for a minimum of 4 weeks from when the bottom is made, which points to a grind higher till at least September 3.  

I had a bearish bias going into the start of last week, but the market proved me wrong.  The big drop in early August clouded my analysis and I stayed short perhaps a couple of days too long.  It cost me about 50 SPX points overstaying the short position, but that kind of rocket higher off a V bottom was so unexpected given how saturated long the market was just a month earlier in mid July.  It shows you how markets have changed in an era where systematic trading and hedge funds all rush in and out in unison, leading to moves happening more quickly, both up and down, with fewer pullbacks than in the past.  No one wants to be caught short, or even underinvested during these V bottoms.  They can kill relative performance for fund managers who are all benchmarked to the S&P 500.  That's why they chase, because they can't fall behind.  Its goes down on oversaturation in long positions, and systematic fund selling and stop losses.  It goes back up on the chase to re-initiate longs to keep up with the indexes.

The latest COT data shows what was expected given the price action, which was asset managers getting more net long.  We also got very aggressive short selling from leveraged funds.  Leveraged funds are not as obvious of a positioning indicator as the asset managers, but you generally do not get big sustained down moves with leveraged funds heavily net short.  You can get sharp, quick drops like you saw in late July and early August, but you usually don't get the 2022 style bear market with leveraged funds heavily short.  And currently they are heavily net short.  

SPX COT data as of 08/20/2024

 

We did see a big increase in call options volume and a big drop in put/call ratios last week, so the options speculators are back to betting on markets going higher.  Not a sell signal, because this has only been going on for a few days, but if the call speculation continues for a couple more weeks, then I would be looking for a possible top in the SPX.  

 

Last week, Jackson Hole was viewed as a market positive with Powell more dovish than expected.  I prefer to fade these post Fed moves, but will wait since its Monday, and options speculators love to buy calls on Monday and Tuesday.  Even more so this week with so many looking to speculate on further upside going into NVDA earnings.

Of course, the big event this week is the NVDA earnings after the close on Wed. Aug. 28.  I am already seeing a lot of calls being bought in the August 30 expiry weekly options.  Almost all the analyst reports are bullish heading into the earnings report.  NVDA has beaten earnings and rocketed higher so many times lately after earnings reports, that the speculators are betting it happens again.  The options speculators have loaded up on calls, most of which will be closed out win or lose after the NVDA earnings comes out.  That's a huge potential amount of call selling that's waiting on the other side of the event.  With speculators selling NVDA calls, dealers will have to close out their short call hedges by selling NVDA stock.  Positioning wise, its setting up for a sell the news event with optimism very higher going into earnings.  I am considering an NVDA short early this week to take advantage of options speculators leaning way to heavily into calls.  

With regards to the SPX, I see very little upside from here, maybe 50-70 points or so, and that's not good enough considering we could easily pullback to last week's lows, which are about 60 points lower.  The odds of a further 50 points higher is probably similar to the odds of a 50 point move lower.  I see little edge there.  However, if we do get a 50 point rally from here, it would be an interesting spot to short the all time highs in SPX going into a seasonally weaker September.  I would rather wait for September to short, but if we get a 50 point rise from here going into NVDA earnings, I may make a small short play for a post NVDA earnings selloff on Thursday and Friday.