Finding Hidden Edges In The Market

 

1/15/26 - Some of the most promising edges in the stock market are found in places traders generally don't look.  Actually, this dynamic occurs across markets.  For example, the majority of traders in the fixed income (interest rates) markets look for events (central bank policy changes; shifts in patterns of growth) to buy or sell rates.  A more subtle approach looks at how rates vary from one another within and across bond markets and trades those relative relationships.  So, for instance, if nothing has changed in central bank policies and in macroeconomic news, one part of the rate curve may be priced cheaply relative to another point, or rates in one region of the world will be expensive relative to another region.  This offers the opportunity to buy what's cheap, sell what's expensive, and profit from the "mean reversion" when rates return to a more normal relationship.  

This is a great example of how we can improve our trading psychology by expanding our understanding and perception of opportunity.

So let's start looking at relative relationships within the stock market.  I went back to 2020 and calculated the difference between the percentage of stocks above their 5-day moving averages within the consumer staples sector minus the percentage of stocks above their 5-day moving averages within the consumer discretionary sector.  These data are readily available on the Barchart.com site.  When investors are expecting growth and a strong economy, they are drawn to the consumer discretionary shares which benefit from consumer spending on things like travel, entertainment, etc.  When investors are expecting economic weakness, they expect that spending on essential staples will continue, while discretionary spending will decline.  By tracking the percentage of stocks in the consumer staples sector above given moving averages minus the percentage of stocks in the consumer discretionary sector, we have a handy economic sentiment measure.

Interestingly, in the quartile of occasions in which the difference between the percentage of stocks above their 5-day moving averages for XLP (staples) minus those for XLY (discretionary) is greatest, the next 20 days of performance in SPY averages only +.42%.  All other occasions average +1.36%.  When investors flee growth relative to stability, that theme tends to continue in the short run.  When we look at the difference between the percentage of stocks above their 20-day moving averages for XLP minus those for XLY, we find a similar pattern 20-50 days ahead.  Forward returns in SPY are subnormal when investors are fleeing to the safety of staples.

The point isn't that you should run to trade this pattern.  The point is that patterns exist where most traders aren't looking.  While the noobs are looking at directional charts, a world of opportunity is being found by the pros in relative space.  When you have more ways to identify opportunity, you build an opportunity mindset.  Better trading leads to better psychology.