One of the things that I spoke to the desk about this past week was being prepared to make the necessary adjustments in their trading as market conditions change. Last week presented the greatest intraday volatility in US equity markets in about a decade. Our very young desk took incredible advantage of the opportunities that were presented to them.
I saw traders that were used to making $1,000-$3,000 in a day making 10 times that amount last week. But on Thursday after the market closed the Treasury and the Fed decided that a comprehensive bailout was necessary for US financial institutions. At the same time the SEC announced that there needed to be a two week cooling off period where investors/traders would not be permitted to make short sales in over 700 US financial stocks.
Those two changes are going to have a dramatic impact in how stocks move in the coming weeks. So our traders must quickly make the necessary changes to continue to trade profitably. Here are a few of the things that I am going to recommend to them at our AM Meeting tomorrow.
1) The overall economic picture of the United States has not changed overnight. Obviously, many of the financial companies have been given a temporary reprieve from the type of panic that was threatening to send them into oblivion. But things are still pretty ugly out there on Main Street and this will provide plenty of trading opportunities. We may have seen a trading bottom in the overall market on Thursday but as earnings season arrives the numbers are going to lead to plenty of stocks being taken to the woodshed.
2) Any stock that trades at a P/E ratio of above 20 will continue to present great opportunity. The way investors’ will view risk in the future will change. We saw this after the internet bubble burst in 2000 and all US equities saw their P/E ratios plummet. With an economy in bad shape investors will begin to think of their downside as opposed to their upside. A few of my favorite high flyers are AAPL, RIMM, and GOOG. They seem reasonably priced based on their current growth rates but what happens if their earnings are impacted by the slowdown in the broader economy? This fear should present good intraday volatility in these names in the coming weeks and months.
3) Don’t be afraid to stay involved in the financials because you can only trade them on the long side until next month. Take a look at the intraday charts for GS, BAC, MS and JPM from Friday. They established intraday support levels and had nice bounces from those levels. My two favorite levels from Friday were GS at 122 and MS at 25.
4) Understand that the magnitude of the intraday moves will be less than they were last week. Look for at least a 50% reduction of the size of moves. Also, there may not be as many reversals.
5) There may be some unwinding of some large short positions in some of the financials. If you notice a significant upmove in one of the financials over a period of a few minutes. Look for a retracement to get long and then a second upmove that will be more powerful than the first. If you see this pattern in reverse in a nonfinancial then use a retracement to get short. We saw this pattern in AAPL and RIMM on Friday.
On Friday we had a solid day as a desk despite the drop in volatility and volume. But it clearly was an easier trading day for those with more than one year of experience. They recognized that it might not be a $10K day but they certainly would be able to grind out a few thousand. Hopefully, our young guys who were killing it earlier in the week will make the necessary adjustments on Monday and extract from the Market what it is willing to give.