Traders seem to have finally forgotten about the Federal Reserve…
They’re also ignoring the end of a great earnings season…
Of course, that’s because they’re focused on the tragic events in Ukraine.
When traders react to news, markets tend to be volatile. We almost always see this pattern every six weeks when the Fed meets.
After the meeting, Chairman Powell holds his news conference. As traders listen to the Chairman, prices swing dramatically in the stock market.
As exciting as these times can be for short-term traders, stock market volatility eventually gives way to buying opportunities for longer-term investors.
That’s why many traders develop a plan when markets are volatile as they have been lately. Most often, these plans manifest as buy lists.
Today, I want to show you how I put together my personal buy lists, and the sectors I’m eyeing as this volatility continues to weigh on the stock market.
Traders turn to two broad strategies when creating their potential buy list.
One is a mean reversion strategy. This is based on the belief that after a sell-off, we should expect at least a short bounce. Some might refer to a rubber band — when it’s stretched, it will return to its original shape when the pressure is released.
For stocks, the “mean” could be thought of as the 20-day moving average. When prices fall far below the average, we should expect a snap back when the selling pressure subsides. This bounce will move prices back toward the MA, or the mean.
Often, prices overshoot the MA and move significantly above that line. In this way, prices are almost continually reverting to the mean.
Other traders will look for a strong uptrend to develop. These traders will most likely look to momentum strategies.
In this vein, I personally value relative strength strategies. This is a type of momentum strategy that shows me which sectors and stocks are outperforming the market.
Check out the table below. It shows the relative strength of each of the major SPDR sector ETFs:
(Click here to view larger image.)
Relative strength in this chart is defined by the performance over the past three months. Values greater than 1 indicate the sector outperformed the S&P 500. Lower values indicate the sector is lagging the broad market.
If traders expect a strong uptrend to follow the decline, they focus on the ETFs at the top of the list. These are the sectors that have been the best performers, relative to the S&P 500, as the broad market sold off.
Some of the ETFs with a score greater than 1 suffered losses but lost less than the index. Therefore, we consider them to be relatively stronger than average.
It’s reasonable to expect the strength of the current leaders to continue as the market moves higher.
But this list isn’t only useful to relative strength traders…
Pick a Strategy, and Trade These Sectors
Mean reversion strategies, for instance, can focus on the bottom of the list. These are the sectors that have been under the most intense selling pressure. Like the rubber band that’s been stretched too far, these are the ETFs we should expect to snap back quickly.
To implement these strategies, some traders will buy the ETFs. Others will select stocks in the sector, often with the same measure of relative strength.
It’s also possible to use call options. This is useful in volatile markets since your risk is strictly defined when you buy the option. You can never lose more than you paid for the option.
For either a trend-following or mean reversion strategy, at-the-money calls work well. These are call options with an exercise price almost equal to the current price of the ETF.
Short-term options expiring in about a month work well with mean reversion strategies. Longer term options expiring in three months or more are best for trend-following strategies.
No matter what strategy you use to trade the bounce, now is the time to prepare.
If you’re more of a mean reversion-style trader, you want to look at the Consumer Discretionary and Technology sectors for stocks that look ready to snap back.
And if you’re more of a momentum trader, you should be buying stocks in the Energy, Consumer Staples, and Health Care sectors.
Regards,Michael Carr, CMT, CFTe Editor, One Trade
P.S. A quick side note on this…
I’m currently beta testing a brand-new trading strategy using relative strength to my current subscribers. We’re calling it Market Leaders, as we focus on only the stocks and sectors with the highest relative strength in the market.
This isn’t available to new subscribers right now, but we’re looking to release it sometime in the next few months, once we’ve put it through its paces. I’ll be sure to send you a formal announcement when it’s available.
Chart of the Day:New Bitcoin Whales on the Scene
(Click here to view larger image.)
Today’s chart is a little bit different.
Instead of looking at the price action of a particular sector or stock, I want to point out an anomaly on this chart, of the number of bitcoin wallets that hold over 1,000 BTC (worth roughly $43 million).
If you’re new to bitcoin and crypto, you might be surprised that we can see this information. But the nature of crypto, where all transactions are permanently recorded on the blockchain for all to see, allows us to see the amount of bitcoin in any registered wallet. We can’t see who exactly owns the wallet, but we can see its contents and activity.
As you can see, in just the last couple days, the number of bitcoin wallets with over 1,000 BTC jumped dramatically. It’s now at levels we haven’t seen since April of 2021.
What could explain this sudden jump? That’s about a hundred new bitcoin wallets worth over $43 million in value, in a matter of days…
Well… are you ready to come along with me on a real crackpot theory?
I think that what we’ve seen so far in 2022 — between Canada shutting protestors out of the financial system and the world kicking Russia out of the SWIFT bank messaging system — is showing large corporations and possibly even governments that they need to have some amount of bitcoin exposure. That it’s important to hold a sovereign store of value that cannot be easily interfered with on the whim of policymakers.
$43 million is a fairly modest position for large actors. So I see this as a trend that’s just beginning to form.
Expect more announcements of large entities holding bitcoin on their balance sheet — as Tesla and Microstrategy did in 2021 — as we move through 2022.
Regards,Mike Merson Managing Editor, True Options Masters