3/9/2025 - The most effective way to work on your trading is to identify themes in your P/L. Suppose you break down your P/L by market condition: rising markets, falling markets, range markets, volatile markets, quiet markets, etc. Suppose you break down your P/L by *what* you are trading and by the patterns you're trading. Suppose you break down your P/L by time of day, by whether you've been profitable or not at the time of the trade, by the trade size, etc. What will happen with these breakdowns is that you'll identify patterns in your trading: what you're doing well, where you're falling short. Before you can work on what's wrong with your trading it's important to diagnose what is working and what isn't. Many times the answer to trading problems is to eliminate what isn't working and do more of what you do well. An analytical journal such as Edgewonk can be very helpful in finding the themes in your trading.
3/7/2025 - So what is the dominant theme in the current market? Many traders would point to the fall in U.S. stocks and, yes, that has been significant. I would argue, however, that the more dramatic and potentially troubling theme is the recent decline in the U.S. Dollar. (Note, simultaneously, the steep rise in the Euro and the British Pound. The Swiss Franc has been rising, as has the Japanese Yen). I find the Barchart site helpful in tracking all this. If you are a money manager, asset allocator, investment bank, or sovereign wealth fund, there is no more direct way to vote for or against an economy than through investment in (or divestment of) that country's currency. The prospect of tariffs and layoffs, combined with the recent sense of rapidly changing decision-making, may be undermining confidence in the U.S. economy. The fall in Treasury yields accompanying the fall in the Dollar suggests economic weakness and the eventual possibility of a cut in interest rates from the Fed. See also the weakness in stocks sensitive to discretionary consumer spending. The challenge of change--personal as well as economic--is to make it both powerful and sustainable.
3/6/2025 - What portfolio managers typically understand and individual traders often miss is that volatility is an asset class. There are ways of trading volatility (especially through options structures), just as there are ways of trading directional price movement. What's more, not only has volatility ($VIX) been ramping up lately in the US stock market, but also the volatility of volatility ($VXX). In other words, volatility itself has been moving around quite a bit. That is leading to large whipsaws in the market. It's important to identify themes in the stock market, it's important to identify themes in individual equity sectors, and it's also important to identify themes in volatility. The "setups" that work in a low volatility market are not necessarily the same as those that apply to a higher volatility market. The patterns we look for in a stable volatility market are not those that necessarily apply to a shifting volatility market. We need to identify all the themes occurring now, study how markets have responded to those themes, and create what Mike Bellafiore calls "playbooks" that apply to the market we're in.
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.
3/4/2025 - One thing I've learned from working with portfolio management teams for many years is that they think thematically. They don't just look at individual charts and decide upon entries and exits. Rather, they scour a variety of markets and see how they are moving relative to one another. In the patterns of strength and weakness, themes emerge that are very relevant to economic growth, stability, and weakness. The first way of identifying themes is in the relative movement of various stock market sectors. For example, take a look at the consumer discretionary sector, XLY. It topped out in mid-December, well ahead of the overall SPX index. Note how the raw materials sector, XLB, topped out even earlier and is well off its October peak. Energy shares (XLE) are off their late 2024 highs, as are the industrial stocks (XLI). Just during the first part of the year, we've seen the defensive consumer staples sector (XLP) outperform the formerly hot technology sector (XLK). All of this suggests a reduced emphasis on economic growth. 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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