With correlation persistently high and so much macro uncertainty out there, trading is going to get bumpy in the short term. That means it’s time to buckle up and sit on your hands if you’re a long-term trader and wait for the dust to settle.
And if you prefer trading the short term? Well, make sure you have your stops set and your antacid at the ready.
Correlation remains annoyingly high — feeding the “risk on, risk off” sentiment roller coaster driving the entire market. In other words, even if you pick a great stock, there is a risk you’ll get washed out as Wall Street moves in lockstep these days.
And as Chris Kimble points out, the Dow is at the very top of its 70-year channel. He writes, “Odds are very high it will pay in the end to follow the breakout or breakdown!” As for which direction will play out? Well, flip a coin.
Other items of uncertainty include the fact that U.S. stocks just logged their best week since June on fiscal cliff hopes … but are predictably faltering this week. And across the pond there is optimism the Greek debt deal that could maybe possibly be different this time … or then again, maybe just wind up as another fairy-tale solution.
Personally, I’m not sticking my neck out at a time like this. I’m letting my longs run but I’m not dabbling in any new trades.
Sure, taking a big risk could result in a big reward if you choose right. Those folks who bought into depressed homebuilder stocks a year ago like Pulte (NYSE:PHM) and Toll Brothers (NYSE:TOL) have been richly rewarded. But one could argue there was at least a factual basis for that housing trade based on a lot of data.
What we’re working with now is the PR machines of congressmen, EU politicians and the risk of a sentiment rally/crash based on hedge funds and high-frequency robots.
For a practical example of this phenomenon, the lynx-eyed Josh Brown of The Reformed Broker points warningly to the recent rally in dead-money tech stocks like Research In Motion (NASDAQ:RIMM), Dell (NASDAQ:DELL) and others as a danger sign — saying it will only end “abruptly and badly” for the small-fish retail investors who get sucked in and try to rationalize the momentum based on “facts” or fundamentals.
Josh may be wrong here, of course. RIMM may be back, as many commenters in my recent screed against the stock pointed out. But he’s smarter than I am and is much more attuned to the Wall Street game of sentiment and riding the volatility, so I’ll trust him and others warning of a short-lived trading bounce here in these tech stocks rather than a sustained rally.
The bottom line is that picking quick-hit winners is a very risky business. I frequently riff on the original sin of trading too much (recently stated here and here). It’s a fault that all traders must guard against — even those who are the very best at this Wall Street game.
So before you trade anything right now, think seriously about the real risks of your trade going wrong just because sentiment swings wildly.
- Ali Meshkati recently penned a great “ode to the short-term trader” that is a must-read. (ZenPenny.com)
- Is the recovery self-sustaining, or just a mind trick? (Zero Hedge)
- For the record, I don’t fear the fiscal cliff … but that doesn’t mean I’m throwing money at stocks right now. (The Slant)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks here.