The Game Taught Me the Game

"The game taught me the game.  And it didn't spare me the rod while teaching." - Jesse Livermore, Reminiscences of a Stock Operator  

Speculation is tricky.  Its not like anything that you learn in school or in a how to book.  There are tens of thousands of books on trading and investing that are overflowing with advice on how to make money.  From experience, most of those books are useless.  Unlike most other skills, people who teach trading/investing are usually the ones who failed at making money in their supposed field of expertise.  That's why so many aspiring traders look for mentors, someone who will teach them the tricks of the trade.  Those tricks of the trade are eerily absent inside the thousands of books sold by the so-called trading and investing experts.  

Trading is a competitive game, where edges get diminished the more that they become known.  So most successful traders are loathe to write a book teaching everyone how they made money.  Or even starting a subscription service.  Or mentoring someone, who could become a future competitor.  That's why you are left with a landscape in the trading education community of a bunch of overconfident, low edge/no edge techniques that permeate and misteach a bunch of eager traders looking for shortcuts.  

As Jesse Livermore said, the game taught me the game.  The best way to learn is to get in the game.  Paper trading won't do it.  Real live trading and putting meaningful money on the line is the fastest way to learn.  Nothing focuses the mind better than having a bunch of money at stake.  I learned the most from my losses, although I don't recommend losing just for the sake of learning.  You have to learn from those losses, and not be hard headed.  You have to manage risk, to stay in the game and to keep learning.  It sounds trite, but risk management is the most fundamental, important, and necessary skill required in this game.  

If my view on this market are correct, the current environment will favor those who have experienced multiple bear markets, and have a less bullish view of the US stock market.  A lot of newer traders, and those with short memories, will be caught off guard.  Too many are positioned aggressively in equities, especially retail investors who are probably the most long on an asset % basis since 2000.  The household equity allocation tells a lot.  This was as of December 31, 2024, when the SPX was around 5900.  But even if you account for the correction, the equity allocation is still historically very high.  

These high equity allocations are facing extremely high valuations, on a forward P/E basis, which are likely overinflated considering the probable economic weakness coming over the next 12 months.  

Fundamentally, you have a Fed led by Powell that is not eager to save Trump and the stock market.  Trump while caving on a lot of the tariffs, is unlikely to completely give up and settle for the status quo, likely wanting some tariffs just to show that all this angst wasn't for naught.  So tariffs will still be a drag on the US economy even if you get trade deals.  

And fiscal stimulus is likely to come only in the form of tax cuts which will only be effective if they are large enough, which will come in 2026 at the earliest.  Its also possible that large tax cuts could spook the bond market and be counterproductive without a Fed that is willing to play nice and help absorb the extra Treasury supply coming from bigger deficits.  You could get a big rise in 10 year yields if the Fed doesn't restart QE if deficits get even bigger.   Powell is around till May 2026, so that's a long time for the stock market to deal with an uncooperative Fed.  

The recent rally has also resulted in higher short selling activity in the dark pools, tracked by the DIX index at Squeeze Metrics.  As you can see, over the past several months, a spike in the DIX has led to pullbacks.  

The COT data, which covered the down move from Tuesday April 15 to April 22, surprisingly showed a small increase in SPX net longs among asset managers.  The overall levels of net longs is still quite high, although well off the highs earlier in the year.  

Its looking like one of the worst environments to be long SPX.  The bulls have enjoyed a lot of success since 2008, and the down swings have not lasted long. The longest downtrend over the past 17 years is in 2022, when we had a 26% drawdown from top to bottom over 9 months.  That's mild for bear market standards.  And what's more important, was that bear market was followed by a huge move higher, from SPX 3500 to 6140 over 2.5 years.  That's a 75% move in 2.5 years.  No wonder the bulls feel invincible about the long term prospects for US stocks.  The HODLers are not in bitcoin, they are in the US equity market.  

I put on a short position late last week and look to add some more early this week to get to a full position.   The risk/reward looks favorable for short positions for the intermediate term.  There is renewed optimism coming from headlines showing Trump caving on tariffs and talking about trade deals.  The talk about the breadth thrust last week was pervasive, showing that technical traders are now bullish with SPX above 5500.  But we are just back to previous support levels which was the local bottom in March.  

There are factors that the bulls have in their favor.   There is relatively low net equity exposure among vol control funds and hedge funds overall with a lot of bearish sentiment showing in the surveys.  If you add the bullish and bearish factors, it appears that the bears have the edge.  If the SPX doesn't pullback within the next 2 weeks, I will reassess my view.  If I am correct, the SPX should start moving lower within 1 week.