Oil Crisis Really Testing Stock Market Bull’s Resolve

The stock market bears have been licking their chops since stocks started to rebound, predicting a second fall and a bigger one this time. Stocks are still holding up pretty well.

The current bear market started, like all bear markets do, with our wondering just how far we’d be sent down before the panic became at least equalized by the value players. It wasn’t that long ago when the obvious move was to run for cover under the weight of all the fear that dominated stocks, either moving into other assets such as bonds or gold, holding your money in cash, or even looking to capitalize on the move by going short for a while.

Eventually, we did reach a point where the panic subsided enough to reduce the downward pressure that it was causing, when we started to see the coronavirus numbers still look pretty scary but the stock market started to become less and less scared of them. This is where the value players who had been sitting on the sidelines in cash started to swoop in, who started to put some serious upward pressure on prices as they sought bargains and found plenty to like after the average stock got a third of their value shaved off.

While the average investor mostly hung on for a comeback, these value investors were seeking the same thing, only being more selective with the way that they played the move. Drops like this can be plenty profitable even if you aren’t short and making money on the way down, because you can capture the differential between where you sold and when you got back in, and the difference is pure profit.

This is a lesson from the pros that the average investor would do well to learn, even though we really don’t get real opportunities very often. We don’t need a bear sized move to do this, as even a more modest pullback where the scare level is less severe but still appears to be predictable enough can add several percent of value to our holdings and be achieved with very little skill. This is all about the mood of the market, and it’s not hard to get a good enough feel for that if you just keep your eyes open.

We don’t want to be messing around with the real small stuff, the couple of percentage pullbacks from a Trump tweet or other not particularly significant event, but these sort of things in combination can provide us a chance to step away for a while and benefit.

Professional traders are always playing these trends, and to do this well requires real skill, much more skill than we may expect amateurs to have. A lot of amateurs learn this the hard way and suffer losses messing around too much with the small stuff, but the bigger the pinata, the easier it is to hit when you swing the bat, and the easier it is to get some goodies out of it.

All you really need to do this is a minimum amount of sense and a good amount of courage. We’re not talking about using technical analysis here or anything of the sort, even the simpler stuff that some books on this might suggest that you try to beat the market, as it’s important not to take on projects that are beyond your skill level. Trading with the mood of the market generally doesn’t require much at all, just to be attuned to it.

These suggestions that we can get from books don’t work all that well anyway, and although you might see the author show you that if you used their moving average stuff or other indicator over time you might beat the market by a decent amount, that’s not really much of a feat. The majority of ideas like this aren’t very good at all, and this includes just about everything out there on the subject, but the biggest problem with them is that they try to do too much, trying to use their approach all the time and not just when the time is right, more selectively in other words.

The market moves up and down all the time in situations that are both dynamic and distinct, where using a trick at one time may work well and may do poorly in a bunch of other circumstances. When we add them all up, we can find that they don’t do much for us using them full time, but still may have their place at the right times.

Most of this is isn’t even suitable for traders, let alone investors, and while there are some much better ideas that traders use, the time frames that these traders use these successfully are too short for investors, way too short usually, and require a level of attention and skill to execute that is beyond the means of even the sharpest of investors.

You can scale these things, for instance trading with weekly or monthly charts instead of intraday or even daily charts that traders use, but our most recent pullback demonstrates quite well the limitations of doing this. Trading with technical analysis always involves some sort of lag, and the lag at the scale that investors need to use can be far too big, like it would have been in 2020 for sure.

It’s not that we couldn’t come up with a good strategy that will get you out for a good part of the moves against you and keep you in during the good times enough to beat just holding your stocks, there will be some times where you get out due to a false alarm and others, like this one, when the bell was ringing so loud that everyone else could hear it well before your signal did.

There is always a trade-off with any technical signal, between the amount of sensitivity and the amount of lag. Too much sensitivity causes you to be whipsawed, with too many false alarms and even one after another in the extreme, and not enough sensitivity can keep you in a move so long that you get out at the bottom and miss the rebound.

The longer the timeframe that you trade, the more difficult this becomes to set right, where you are mostly acting on the meaningful signals and avoiding most of the false ones, the noise. With longer timeframes, the ones that investors would use, getting the signal to fire involves larger amounts, like having to give up 20% of the value of your portfolio before the signal kicks in, which would have dropped you off right at the bottom of the 2018 bear market and had you out for a lot of the rebound as well, and would have seen you not even benefit from this last one, saving some of the drop but missing out on the rebound so far as well as you sit on your hands.

Another big issue is that you not only need to know when to get out, you also need to know when to get back in. There is therefore two ways that you can screw this up, on the way down and on the way back up. This can be done well by those who really know what they are doing but not so well for people who are basically neophytes in this game, whether they may realize it or not.

This will be a challenge as well to manage with technical indicators, and while this can be taught, it’s hard to find good lessons as the people who really know what they are doing are successful enough to not need to share, and those who share tend to not know that much about what they are doing. This is a big enough project for traders and is well beyond the interest level of investors, even those who may be pretty keen.

Most of What Matters is Happening Right Now

Traders who are exceptional focus more on the present, and this is the only real good way to strive for the efficiency that can make trading work best. If you are good, you can come up with some good mechanical systems, the sort of things quants design and plenty of traders seek to master, but this involves that we take every signal that the system generates and there’s no opportunity for differentiation. You may seek to refine it all you want, but none of your refinements can be made specific, and all apply to every trade you make going forward.

These traders have highly developed skills that place their focus upon the current pattern and whatever other useful information that they have, and they apply what they see to the specific trading situation that they are in. An example of this would be to use the speed of a move as a means to decide how long to stay in a trade, like for instance when news hits and things really take off when a big sell program kicks in.

These programs behave differently at different times and you couldn’t really teach a computer how to handle this all that well because there are too many variables, and a big part of this story is told by the news itself, which of course is specific and can’t be generalized well.

A lot of the reason behind why some traders are exceptional is that they have developed such a good sense of being selective. We can all use any amount of discretion with our trading, but they are just better at this than just the good traders, and especially better than all those traders who want to take the yoke of this jet without enough flying experience or even adequate lessons.

While traders honing these skills is an arduous task, the good news is that this is all made far easier for investors, because the moves that they are looking to use discretion with are so easily spotted. This is what we refer to as measuring the broad mood of the market, and where the big bouncing ball we’ve had this year can serve to be instructive.

This is still a game where skill is rewarded, by becoming finer with our brushstrokes even though we may be dealing with a fairly long average holding time goal, but even a wide brush could have painted over quite a bit of the pain that so many investors suffered lately.

This is not something that anyone should have missed, and this one even had the dogs howling. To pull this off anywhere near sensibly, you could not have just relied on the charts ad this is a great example of how even the shortest-timeframe traders need to be taking other things in account sometimes. Even the microsecond per trade programs look at this stuff, and actually base a lot of their trading upon it.

While we still need the chart to play along, a down bar when the world is thinking that we’re in a huge crisis is a different one than normal, much different. Investors need to seek out the situations that are really that different, and confine themselves to using their big brush only when the overall mood of the market dictates.

This still leaves us with the other side of things, when to get back in, and this one isn’t quite as easy but not all that difficult. We’re looking for the situation to turn, for the fever to break, and getting in below your exit always beats the buy and hold play, and by that exact amount, no matter what happens after that.

It’s All About Being on the Horse When it Is Not Too Angry

A good entry after a pullback always looks like a big line down followed by a little line up, like an inverted check mark, and the little line is the important one here. The mood might be changing, but if we don’t see this little line, it’s not time yet, and we especially want to avoid riding the line down a fair bit more. This still would beat the buy and hold by the amount we were out though but this still needs to be avoided.

Our check part of the check mark shouldn’t be too big, but it also can’t be too small either, where we don’t have enough confirmation that the change in mood is translating to stock prices enough yet.

We wanted to see the value players get in a game in a committing way, and while this was pretty close to the bottom, it wasn’t too close when we made this call for a reversal. We’ve moved up quite a bit so far and those still waiting would have missed all of that, and when they finally do enter, we will beat them by the difference that they missed out on.

The rebound is well underway, but along the way, there have been some real doubts about our avoiding a second significant down move, one that may take us below the first bottom. While anything is possible, we told you that we feel that we’ve built enough of a base to give today’s situation enough support to make that not enough of a concern to be out even though the coming news may be pretty bad.

We still feel that way even though Monday and Tuesday have been pretty bearish for stocks and the situation with the oil market is definitely a scary one. We can’t just trade the charts, or just trade the news, and the truth lies in between, by giving each their due.

We actually like the action over these two days, and the reason is that this news was overwhelmingly bad and the market held up very well under this intense pressure. It is not the oil glut that is the problem, or however low the price of oil goes before it rebounds, it is the fact that demand for oil is this low, which tells us that our economy is dreadfully sick, perhaps a lot sicker than we thought.

Monday’s collapse of the WTI May oil futures was only part of the story, and what matters even more is the spot price of oil which is the one that really tells us what is going on in the real world and not just in the futures market. Even futures traders don’t pay enough attention to this, but investors sure don’t.

The good news is that we saw spot prices of oil make a big comeback on Tuesday, even though there are still areas such as in Louisiana which are still paying people a lot of money to take oil off their hands, $35 a barrel as of Tuesday’s close. The spot price reflects current demand, while the futures price tries to guess at where it will be in the future.

It’s not that we just found a solution, or that oil demand really picked up that much. Rather, this can only be explained by the spot market panicking about the May expiration just like the futures market did. It’s not that Tuesday’s prices were all that much to get excited about, but they looked like they were just from a market that got clobbered on this planet rather than the strange and inverted one we visited Monday.

We did seriously question yesterday’s WTI June’s level yesterday, due to the huge gap with spot prices, and even though the spot market wasn’t near as horrific as it appeared Monday, WTI has been speeding toward the spot price ever since. We knew that we were headed here, we just didn’t think we would cover this much ground in just one day.

The good side of these prices converging more a month out from expiration is that oil futures prices will be more representative of what may actually happen. Demand may improve by a decent amount in a month, but not by that much, and there’s also the issue of our storage crisis worsening, as we use more and more of it up each day now.

Sometimes you can learn more about a market’s resolve when it is going down rather than up, and this current move sure showed us that it can take a punch. This was a pretty big punch and a bigger one than it appears given that the market has been rocked but remains well on its feet. This is a lot bigger deal than Saudi oil wells being hit, for more reasons than one, not only the scale of this but especially what it represents, the leading edge of a very big fire. This is the big one with oil, and the explosion did not blow us up.

The flames will burn pretty hot as we unravel the mess that we have created and discover some pretty charred items, but with so many keeping their eye on the horizon instead of just what is at their feet, we’re still in pretty good shape here.

John Miller

Editor, MarketReview.com

John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.

Contact John: [email protected]

Topics of interest: News & updates from the Securities and Exchange Commission, Stock Markets, Bonds, Loans & more.