Trading is situational.
Without context, breakouts always look bullish…
On the flip side, when the market falls, it’s also easy to fall into a bear trap.
Sure, context can help make sense of a stock’s chart… but many times traders just rely on the chart.
So, the chart becomes the primary driver of their decision.
But trading off chart patterns alone guarantees terrible performance…
Take the SGI Cross Asset Trend Following Index, which tracks the performance of trend following signals across stocks, bonds, and commodities.
In a nutshell, these systems are long when the market is above a trend or moving average… and neutral or short when it’s trading below it.
Since Q1 2015, it fell 6.5% while the S&P 500 rose 116%.
All that time and energy spent poring over some pattern on a screen could’ve been spent elsewhere – all while doubling your money just by being passively invested in the markets.
This shouldn’t be a surprise since trend following is the most accessible form of trading… anyone can get access to charts and open a brokerage account.
And if anyone can do it, then it’s close to worthless… as the data has clearly shown.
I say this because the market has recently reclaimed its 50-day moving average (MA) on Friday. Just like the bears were getting too excited about getting vindicated for their negativity a couple of weeks back – the bulls are making the same mistake now…
Now a week later – with the S&P 500 having reclaimed all of its moving averages – all headlines are pointing to the strong showing of big banks’ earnings.
The bears are frustrated again, and soon so will the bulls. That’s because we are entering a choppy zone in the market, as Jeff Clark pointed out last week.
I know the charts are showing something different right now, but for the next three weeks, the markets will be driven by earnings. And this is where context comes in…
Earnings just started…
And it’s rarely a smooth ride…
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There’s always the one earnings miss that sends everyone running for cover.
Last time, Amazon’s big miss sent the market down from its highs.
And the last 12 earnings seasons only generated a grand total of about a 1.5% return for the market. Since each earnings season lasts around three weeks, that represents almost a full year’s worth of price action.
Yet, as a whole, the market rose 67% during the same stretch.
That means all of the market’s gains have come outside earnings season.
Meaning, earnings are just one big choppy mess.
Take a look at how the last three earnings seasons (blue circles) looked on the chart below…
Each of the last three earnings seasons coincided with a brief drop towards the S&P 500’s 50-day MA.
So, you might argue it’s best not to do any trading at all during this time.
Traders should realize that they don’t really have an edge when it comes to trading off charts without context… and the potential for losses becomes even worse considering the havoc earnings season can do to chart patterns.
So, even though traders are seeing a big, beautiful breakout in the S&P 500 right now, I think there’s a greater chance that it retests lower levels during the next few weeks than move straight up towards new highs.
Regards,
Eric Shamilov
Contributing editor, Market Minute
Reader Mailbag
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