Sitting Tight

This game is 90% psychology.  You can read all the trading books, filled with cliches like "cut your losers" and "ride your winners", and it won't help you at all unless you can control your lizard brain.  We are all just animals that evolved to be good at survival and reproduction, nothing more, nothing less.  We didn't evolve over the millennia to be good at trading.  Being good at trading is not natural.  We evolved to hate losing, because that lowered our odds of reproduction and survival.  But that hatred of losing is what causes us to hold our losing trades longer than our winning trades.  Taking losses is admitting to being wrong and accepting defeat, things that didn't help with the goal of human survival and reproduction over the past 100,000 years. 

In the 1970s and 1980s, before the proliferation of technical analysis based trading and trend following systems, trend following was a simple, but very profitable trading strategy.  Trends would last a long time because so many traders were reluctant to take losses when losing and were quick to take profits when winning.  Trend following doesn't work so well anymore because there are so many trend following CTAs and hedge funds that follow systems that ride the momentum.  With so many more speculators trend following, it has created more false breakouts and trends that die out more quickly.  

Trend following still works, but it works better now in shorter time frames, rather than in longer time frames as in the past.  One of the things I've noticed in the SPX is how often you have trend days, but that most of the move is finished by lunch time, rather than by the close.  Systematic and HFT traders have become so quick to recognize and catch the trend that an up move that would normally be spread out over the whole trading day is instead compressed into the first 90 minutes.  The same goes for a down move.  This is valuable information for those who are looking to optimize their entries and exits during the day.  If you are going to short when the market is near the highs of the day, rather than shorting at 10:30 AM ET, its better to let the up trend go a bit more and short at 11:30 AM ET.  Or since you don't see too many intraday trend reversals, if it looks like a trend day by 10:30 AM, its probably best to just short in the final 30 minutes of the trading day.  

Overall, the market has gotten more efficient for shorter time frames, so its hard to generate alpha fading the intraday trends.  Its why I've gone from daytrading almost everyday to daytrading maybe once or twice a month.   In the HFT/hedge fund dominated short term trading world, retail traders are bring knives to a gun fight.  Trying to eek out gains through short term trading is exhausting and inefficient.  You are battling better capitalized, better informed traders on the other side.  Its a hard way to make an easy living.  

Back to the market.   The price action and news flow before Wednesday presented the setup.  One can either choose to wait for some price confirmation before entering shorts or to try to pick the highest price possible by selling strength.  There are pros and cons to both strategies.  I prefer trying to pick tops because it reduces the risk of getting whipsawed by short term movements.  But it increases the risk of being early on the short.  There are tradeoffs for both methods.  Its not easy trading the short side during a raging bull market.  But it can be done if you are picky with setups and only shorting when many things are lining up in your favor.  

As I mentioned last week, I thought the coming selloff would be just as steep as the rally was in the first half of July.  That's why I didn't want to wait for confirmation of weakness to short, because it would be hard to chase the weakness to put on a short position.  We've sold off 162 points in SPX over the past 3 trading days.  That's nearly 3% in 3 days.  It has taken the VIX from 13.19 to 16.52 during that time.  Its a fairly emphatic move coming off the high volatility, euphoric (for small caps) trading action that we saw early last week.  All you heard was how bullish it is for the market with Trump's election odds going higher.  People were talking about Trump trades and the strong breadth in the market with the Russell 2000 squeezing higher.  People forget how small and illiquid the Russell 2000 index is.  The market cap of the whole Russell 2000 index is less than the market cap of NVDA.  It can be jammed and moved easily with a few billion in ETF flows, which is what you saw over the past week.  

The weakness last week in the face of all the good news that came out is a good sign for shorts.  It points to a high probability that we reached bull saturation and upside exhaustion.  Add to that the seasonal patterns turning negative from post July opex into early October.  Plus the addition of election uncertainty, which keeps implied vol elevated, which increases the deltas of out of the money puts.  The market hates uncertainty, and that will help to keep a lid on any rallies from here till October.

Market participants have remained complacent and have been ignoring the selloff, hardly reducing their call buying, and there hasn't been as much put buying as one would expect with the SPX down 162 points in 3 days.  The ISEE call/put index has only slightly dipped, unlike the selloff in April, when it dropped big, and stayed down there for several days.  

The OCC put/call opening transactions data confirms the ISEE index readings.  The level of put buying barely increased, and the level of call buying barely decreased.  This is unlike what you saw during the April selloff, when the call buying decreased quickly, and the put buying increased quickly.  

The COT data now shows that asset managers are now the most net long SPX futures since early 2020, making them longer than they were at anytime during the bubbly 2021 market.  This is happening despite the steady decrease in open interest in SPX futures since 2020.  Micro E-mini SPX futures showed small speculators getting heavily long from July 9 to July 16.  

Anecdotally, the complacency is much greater now than in April.  One of the reasons I didn't get short in early April was because there wasn't that much euphoria or enthusiasm despite the strong uptrend.  In April, there was still a wall of worry about inflation and bond yields.  This time is much different.  People are bullish with the cooler CPI readings and the softer, but not too soft economic data, increasing the calls for a soft landing with the market now expecting, and very likely to get the first rate cut in September.  Early last week, there was lots of  bullishness and enthusiasm for this market, just from listening to the experts on CNBC and Bloomberg.  

News has come out that Biden has dropped out and endorsed Kamala Harris.  Politics is overrated, as both Democrats and Republicans have budget busting fiscal policies, so there isn't as much difference there as the pundits make it out to be.  Harris is a very weak and unpopular candidate.  First, all else equal, women politicians are less popular than male politicians.  Same goes for black politicians vs white politicians.  Obama was an exception, not the rule.  Second, Harris has already shown her weakness in the 2020 Democratic primary, being less popular than Biden, Sanders, Warren, and even Buttigieg.  

With this decision by Biden and the Democrats to pick Harris, it has handed Trump the win in November.  If the Democrats picked a moderate like a Joe Manchin as the candidate, it would be an almost automatic victory vs Trump.  Even RFK Jr. would be an almost automatic victory vs Trump if he was the Democrat nominee.  There would be many anti-Trump Republicans that would vote for a Manchin or RFK Jr. over Trump.  Almost none would vote for Harris over Trump.  Not to mention independent voters who would overwhelmingly prefer a Manchin/RFK Jr. vs a Trump.  But that will never happen.  Despite my view that Harris is almost a lock to lose vs. Trump, the betting markets won't feel that way, and that's what the financial markets will be pricing off of.  No amount of donor money coming into Harris will help her.  Luckily for the Democrats, her political career will end with this election.  The uncertainty of the election will linger, as many will overrate the chances of Kamala Harris vs Trump.  And there is a Democrat convention coming up in mid August, which I'm sure many fast money traders will be reluctant to be long into.

Initial price target for this pullback was SPX 5450-5470, but it may have been too conservative.  Given how traders have reacted to the 3 day selloff, its added to my conviction that we're going to get a significant selloff.  I now think that my final price target of 5360-5380 was too high, and that 5250 is now a reasonable price target for early to mid August.  I will be more patient with my short covers and more willing to re-short on any bounces for the remainder of July.