Sunday, February 07, 2016

How To Trade With Macro Winds To Your Back

What does it mean to have the wind to your back as a trader?

Many would respond in terms of trend behavior.  You have the wind at your back, many believe, if you are trading in the direction of the trend.  

A different way of viewing wind at your back is aligning yourself with the behavior of the largest market participants.  If you can see large institutions lining up on the buy or sell side, you have an opportunity to be nimble and participate.  Rarely are large directional participants trading for a matter of ticks.  Rather, they are trading on the basis of macroeconomic themes that provide the fuel for market trends.  

So how can you identify macro themes in the making and place the wind of portfolio managers at your back?  Three ways stand out:

1)  Watch intermarket correlations - When money managers are placing bets on macro themes, those themes find multiple expressions across currency, equity, and rates markets.  They also find expressions across global markets.  When you see correlations rise among assets, there's a good likelihood that the correlations are part of important macro themes.  A good example during 2016 to date has been the high correlations among oil, stocks, and emerging market currencies.

2)  Watch volume and volatility - If institutional participants are betting on a theme, you can expect volume and volatility to expand in the direction of that theme.  A market with low volume is a market dominated by market makers.  They do not make their living trading medium-term market themes.  When large, directional participants enter a market, they contribute volume and that contributes volatility--especially when market makers stand aside to avoid getting run over by large directional flows.  In the stock market, you can see where enhanced volume leads to high levels of upticking or downticking across a large group of stocks (NYSE TICK).  That's a great tell for enhanced directional interest.

3)  Watch relative performance among stock sectors - Many times we see macro themes reflected in the relative performance of one stock market sector versus others.  For example, energy stocks for quite a while underperformed the overall market and underperformed consumer shares as part of the weak oil/deflation theme.  Recently, we've seen concerns over global debt weigh on the relative performance of banking shares both within the U.S. and globally.  When sectors persist in underperforming or outperforming, the chances are good that there's a macro story involved.

It's a common mistake to become tunnel visioned during times of market stress and only follow the position(s) you are trading.  That blinds us to the waxing and waning of macro themes and the influence of large market participants.  You may not trade the markets thematically yourself, but it helps to have those themes at your back--and certainly not in your face.

Further Reading:  The Most Common Mistake Losing Traders Make