Stock market on January 12, 2018: outlook


*These are my discretionary thoughts on the market. My Medium-Long Term model determines my trades.
Go to the homepage for my latest market outlook. I update this webpage throughout the day.

Thoughts

  1. When will the stock market top?
  2. Every single stock market is insanely overbought.
  3. The buying opportunity of a lifetime.
  4. Study: what happens when RSI > 80 on every single time frame
  5. Study: stock market volatility will rise in 2018

3 pm. When will the stock market top?
This question is on everyone’s mind. The honest answer is that nobody knows. We never found a consistently accurate way to predict tops before “small corrections”, which is why the Medium-Long Term Model only predicts “significant corrections”.
The S&P 500 is extremely overbought right now. Here’s the S&P vs its daily RSI 14.

When momentum is this overbought, any bearish news can trigger a correction.
The NAFTA renegotiation is a potential bearish trigger. Congress (Democrats and Republicans) will ultimately block Trump if Trump pulls the U.S. out of NAFTA. But in the meantime, Trump’s actions will probably cause a lot of uncertainty and market turmoil. Political uncertainty coupled with an extremely stretched rally is a dangerous recipe.
Investors and traders are heavily long U.S. equities. Thus, a tidal wave of stop losses will be triggered when the market starts to fall. The triggered stop losses will reinforce the correction’s downtrend, which is why the next correction will probably be closer to 10% than 6%.
7 am. Every single stock market is insanely overbought.
Global stock markets are going up incessantly, and this has put some cautious investors/traders on edge. Here’s the S&P 500.

Here’s the MSCI World Index

Here’s Hong Kong’s Hang Seng Index

In short, momentum around the world is EXTREMELY overbought. Today’s study demonstrated that when stock markets are extremely overbought, this tends to happen:

  1. Short term bullishness (i.e. bullish over the next few weeks).
  2. Medium term bearishness (i.e. a correction in the next few months).
  3. Long term bullishness (i.e. no significant correction or bear market ahead).

As a result, I still think the U.S. stock market needs to wait until January is over before it can begin a correction. Earnings season is about to start, and stocks go up/flat more often than they go down on earnings season.
This will be a correction in global stocks – not just the U.S. stock market. Stock markets around the world are highly correlated nowadays.
7 am. Buying opportunity of a lifetime.
After the S&P 500 makes a correction, that bottom will be the buying opportunity of a lifetime. The next correction fits the Volatility will rise in 2018 study.
Everyone knows that the long term outlook for the economy and stock market is wonderful. The next correction will be a “buy the dip like crazy” moment. The majority of investors know that we are in the final quarter of this bull market, but that the stock market still has room to run. So their buying will most likely cause a V-shaped correction.
This once-in-a-lifetime buying opportunity applies to non-U.S. stock markets as well. This bull market will end in a full-blown global bubble.

Outlook

Here’s what I think will happen based on my discretionary outlook.

  1. The S&P will make a small 6%+ “small correction” in Q1 2018. The current rally is the longest one in history without a 6%+ “small correction”.
  2. The S&P 500 will close higher at the end of 2018 vs the beginning of 2018.

I do not use my discretionary outlook to trade. I remain 100% long UPRO because my Medium-Long Term model does not foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.
I have been 100% long UPRO since September 7, when the S&P was at 2465 and UPRO was at $109.3
*I also have a small Day Trading portfolio. Click here to view my day trades.

25 comments add yours

  1. I’ve got my dry powder ready for the small correction!
    Question: when placing trades, is there a dollar size above which you’ll split it into multiple trades?
    Or would that only matter with pretty massive trades (like institutional-sized)?
    Thanks!

    • No point in splitting trades.
      We didn’t even do that even with the fund. We’d adjust the limit $ on the order.
      E.g. if we’re buying 1 million of XYZ, that’s obviously a big order. It could take them a long time to fill that depending on your market’s volume.
      As the market’s price moved, we’d move the limit order’s $ as well.
      The problem with market orders is that those get hunted by HFT’s. If the HFT’s see a large market order, they’ll jump into the market in front of you, bid up the $ and then sell you the stock at a higher $. It’s pretty annoying, which is why limit orders are the way to go. Limit orders tend to get better fills than market orders.

  2. Troy I’m a stuck es short. About 15 handles higher than your short but still getting crushed…. where are u looking to cover???

    • I think the model will cover soon. At least the gains from longs will more than make up for that loss.

  3. Woke up rather paranoid today, then even at the smallest dip, folks will just buy and cause it go right back up, i.e I’ll miss the opportunity.
    It sucks to be all cash. 🙁

  4. T. Boone Pickens closing his hedge fund stating that trading in oil has lost its luster
    Most likely because of the machines totally taking feel out of the marketplace
    The United States government has to limit or outright completely ban non-human algorithmic trading in the United States stock marketplace…
    There is no level playing field… it’s gotten to the point that 35+ year NYSE floor veterans are completely lost, lost all feel for the markets, making the human trading decisions lose all feel.
    Historical Backtesting is beginning to be a complete waste of time with robotic trading. Since all backtesting was done with humans making trading decisions. We have to start backtesting algorithmic computer models!
    The future of stock market trading will be with one computer fighting one another for ticks as all volilitility will completely dry up.

    • The backtesting still works. Something like seasonality works over the long run. It can be wrong on a case by case basis.

    • Computer programs trading stocks are created by humans. Since humans are fallible, computer program trading is fallible too.
      For example, after the Brexit vote, Charles Schwab stock went down about 10%. Which was absurd, for Schwab had nothing to do with Brexit. My take is that Schwab stock was pounded down by computer program selling of stock–because other stocks in the financial sector were going down.
      The negative impact of Brexit on the financial sector was greatly overblown.
      A couple of days after Brexit, I bought additional shares of Charles Schwab stock. I wish I had more cash available at the time.
      Charles Schwab stock is now about 100 percent higher from its Brexit lows.
      The point is, it is possible to create trading methods that are better than algo trading, because the algos are created by fallible humans too.

  5. Troy, 1) based on the stock market trading 6 months further out, and Based on the banks reporting today stating very big Yuuuuge profits in the future quarters because of the tax cuts.
    2). How will there be a correction with everyone chasing to get in to participate in these Yuuuge qtr over qtr bank earnings with record profits because of lower taxes. If the market trades 6-months going out, it must be parabolically impossible for your 1st quarter small correction prediction. Any very small dip will be bought with excessive amounts of cash & managers chasing to get in to participate in these yuuuge bank profits

    • It can be one of 2 things:
      1. Large profit taking. This is the less likely scenario.
      2. You have an exogeneous event that suddenly makes everyone realize things aren’t as rosy as they seem. This could be Trump pulling the U.S. out of NAFTA (which ultimately won’t go through, but there will be a showdown in Congress). When everyone is so long, a small decline will trigger a ton of stops on the way down. The selling becomes self fulfilling.

  6. Once a small correction starts, how would you decide when to get back into the market (the bottom)?

    • It’s all about risk:reward. If I were cash, I would get in at 6%. At most the S&P will fall another 5-6%. But the upside over the 1-2 years could be 20%, 30%, or even 40%!

  7. Troy, your day trades have been rocking it. The closed 33 trades as of 1-12-17 have an average return of around .48% with an ave 2.15 day hold time per my calculations. If you can keep that up all year it would be incredible!!!!
    My question is do you consider the day trades an “all weather” system which would have similar performance should we run into that potential small correction?
    Thanks!

    • Hi Rich. The performance would deteriorate a little in the event of a correction, but not by a lot. It isn’t 100% consistent, and the model is still a work in progress.
      Kind regards,
      Troy

    • Hi,
      May I ask what are the 33 day trades being referred to? Is it some suggestions on trades with timing and target price?
      Thanks.
      Alex

  8. Troy what is your plan on existing your es 2748 short position? I myself am short from 2765 and feeling the pain! We rallied 120 handles in the first 9 trading days of the year and could barely get a 5-handle pullback! 2668 was the last closing price of 2017 & 9 trading days later 2790! Outrageous? I can’t seem to get profitable trading es in over 10 years! This is indeed unprecedented. The cover of the New York Times will read FOMO. Fear of missing out on saturdays front cover! I’m now in a day 1 margin call on 4 lots short. I was lucky I bought at the small dip in the beginning of the week at 2740 to make a 5k profit just to wash it all away on fridays close! Looking on the weekly chart it still looks like we need another 4 weekly candles of parabolic price moves with perhaps a divergence in rsi which would bring us to the 2nd week in February before a let up with this momentum…

    • I think the model will add to the short one time, and if that doesn’t work out then cut the $ES very soon. Matt, what you’re missing out is that overall, the day trading portfolio is net long. So the gains on longs are more than making up for the losses on shorts.

  9. Hi Troy,
    I am a very beginner. Do you recommend to set stop loss? If yes, would you use the stop trailing limit/market or a simple limit order? And what % would you recommend?
    The Marijuana stock in Canada got a big sell off and drop 30% just because of profit taking, I think. There is no news at all. But as you say, since there is already a big gain, a small dip will trigger a big stop loss sell. And when it drop 15%, more and more people want to sell just to protect the profit. What strategy would you recommend?
    Thanks.
    Alex

  10. Troy,
    I really feel that the hedge fund down the road from my house Renaissance Technologies trading model is based on the psychology of KISS. But not sure how to backtest it if it is the right model? I believe there model is based on 3 things:
    1). Putting large amounts of capital into the market on the 1st trading week of each quarter, (riding the waves of fresh capital inflows of institutions, fund managers chasing quarterly performance) then existing on the 2nd week of each quarter to protect large profits
    2). The week before every major U.S. Holiday re-deploying large amounts of capital. *the week before Memorial Day, * the week before 4th of July * the week before Labor Day, & then *the week before thanksgiving. Then existing into the close right before the last closing day before the actual holiday begins. The psychology behind this model is that 2/3rds of the U.S. Economy is driven by retail spending. If consumer confidence is low the week leading up to these 4 major U.S. Holidays with the market being down, then consumers will not spend money.
    3). I’m sure ren Tech laughs at all the “pros” backtesting every technical study and indicator, where they do the inverse trades further fueling high profits on the “pro mbas master technical backtesting strategies” where they have the simplest easiest trading model strategy! Based on 1&2!
    Would you be kind enough to backtest 1&2 in a blog post to see if this indeed is the most profitable strategy to follow as I lack the resources to do so.
    Thank you,
    Massively frustrated estrader Matt

    • Hi Matt,
      I disagree with regards to Renaissance. From what I’ve heard, their models are anything but simple. There’s no way they can consistently generate that level of return with such a simple model.
      I’ll try 1 and 2 when I get the chance.

  11. Troy, when do the Natalie talks/negotiations start? If this is the possibility of uncertainty in the marketplace that starts the trigger of overbought selling?

    • Next round ends on January 25 I believe. Final round is to be decided, it will be in late March.

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