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.