3/5/2025 - A key trading skill is identifying themes early in their unfolding. Once the theme is obvious and well-subscribed, it is often subject to reversal as the latecomers are squeezed from their positions. Yesterday I heard a lot from traders about the market weakness, concerns about recession and inflation, etc. Just a couple of days earlier, the discussion was much more about buying weakness, playing for the bounce, etc. No question, we have seen expanding weakness in the U.S. stock market. Small caps (IWM) and consumer discretionary shares (XLY) have been particularly weak. Indeed, yesterday we had well over 2000 stocks on the NYSE make fresh one-month lows. When that has happened in the past, results have been mixed in the near term, but relatively strong 20+ days out. Most notably, the near term results (3-5 days out) have been very volatile, with large gains and large losses. Also across the NYSE yesterday, we had fewer than 20 stocks close above their upper Bollinger Bands. That absence of weakness has been associated with favorable returns (bounces) over the next few days. What all this is telling us is that market themes have a shelf life. When they become obvious, that is when continuation becomes less certain.
Notice how there is a pattern to all this: First we see reduced participation when the broad index makes marginal new highs and then we see *changed* participation as bear market activity commences. The relative action of the stock market sectors tells us whether the themes dominating investors are related to growth or defensiveness; whether we're seeing broader participation or reduced participation. Charts can be very helpful in identifying points to enter and exit when you get to the point of executing your trades. But it's themes that provide the most reliable information re: *what* and *how* you should be trading.
Further Reading:
Understanding Market Themes From Sector Breadth
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