A Trader Trades; Time To Go Long - Here's Why And How

by: David H. Lerner

A trader trades. No disrespect to those how are consciously on the sidelines, or even short. Just don't do it out of fear.

My confidence to go long comes from two very strong bounces creating a good support level.

Let's not get fancy with individual stocks right now. Go with these ETFs.

My gut says the market wants to go higher, and we may be surprised how high.

A trader trades

This invites the opportunity to explore and question. First of all, you might be a trader but not wanting to trade at this moment. I respect that and all the power to you. If you feel that this market is too risky for you, you are still a trader, and holding cash is also a trade. I just want you to be conscious of your decision and not let it be about fear. So let's go through a few items to establish why even though we seem to be on a knife's edge that it's a good risk to get active again.

Following a time-worn pattern

Very simply, we saw that the rally was (temporarily) stalling out, and vulnerable. We pointed out that the Powell "put" cutting rates would kick-off a jag of selling. In no way did I see Trump raise the tariff or that China would devalue and that Mnuchin would call China a currency manipulator. I never said that; instead, I showed charts where the uptrend was decidedly broken and that was predictive of further downside. I went down from 3% to 5% to a range of -5% to -7% only because the charts told me so. So to me, in times like this, technical analysis and historic patterns are my guide. So we had our 5% to 7% slide, which is the same range that we had in the slide at the end of May. Sorry, but patterns repeat, they just do. Here is the whole (and typical) pattern:

  • The predicted 5% to 7% slide.
  • Then we had the bounce, that was nearly a 50% retracement (typically over a few days, not in hours).
  • We retested the previous low ~2823, in fact at a slightly higher ~2826.
  • We had a near-historic reversal on that test.

Just like a double top is an indication of a limited upside, a double bottom is an establishment of a strong base of support. So now as a trader, we have our parameters for a trading range. Let me make the case stronger for you. We had that reversal, and it was one of the largest reversals recorded on the Dow, and the S&P was not too shabby either as it dropped 50 points and then bounced all the way back. That kind of reversal should not be ignored, and also that bounce we had on Tuesday was mighty powerful. I have to conclude that the market wants to go higher. My case for getting back in is simple. We can trade against that 2823-2826 level; if the S&P decidedly breaks that level, you can use that as a stop. Furthermore, we have the double-top on the S&P so let's decide to take profits at some level below 3000.

I hope that some of you decided to trade yesterday, but there is still upside

The title of my piece yesterday said it all: "Yesterday's Rally Surprising, Testing The Prior Low Shouldn't Be; Holding The Prior Low Is The Buy Signal," We had the buy signal and as a trader, many of you, I hope, took the initiative on your own. That said, this piece is for those who decided to hold back. Please remember we don't trade the S&P 500, we just use it as a reference. Our strategy, for the most part, is to concentrate on the areas of the market with wider swings to the index, the high-beta names, giving us great alpha, or special situations that should give us good returns as a trade. I do try to write for the three classes of market participant, the trader, speculator (as I describe it) and long-term investor. This note is for the trader and longer-term trader that I call speculator. So this analysis needs one more set of items that you must go through in order to get more active again. You should NOT be active (or long at least) in this market if:

  • You believe that we are tilting into a recession, because of political uncertainty.
  • That further tariffs will kick off a bear market.
  • That the slowing global growth will affect our stocks.

I don't believe any of these things. In my experience, if you let your political beliefs affect your investing strategy, you will have lost a lot of money by now. All the tariffs until now have not given us a bear market, and the US is insulated from the rest of the world because we are a consumer-led economy. Also for the speculator, if you buy equity on the premise that we are disposed towards the upside and we stall out, you should still be comforted knowing that if you hold for 2-3 months you will be rewarded. If you don't have that confidence, stay out of this.

So here is what I suggest

Now is not the time to be picking individual stocks, though a lot of great names are underwater. If you have the inclination and as a speculator, a lot of high-beta individual names are way down from their highs. Over the next few weeks, you can bet that I will be highlighting those names. This note is focused on a trade and I want to just highlight 4 ETFs that I think could give returns, especially if you decide to use options to give some leverage as well. So they are:

  • IGV the software ETF. Just a bunch of great software names: Adobe (ADBE), Oracle (ORCL), Microsoft (MSFT), Salesforce (CRM), Intuit (INTU), ServiceNow (NOW). The range of capital weighting is 9% to 4.5%
  • FDN the "FANG" ETF. I went through the breakdown in my Monday piece.
  • XLK the tech ETF. Microsoft 19% and Apple (AAPL) 17%. Also Visa (V), Mastercard (MA), Cisco (CSCO) at 4%.
  • ITB the housing/Builder ETF has the homebuilders and also a lot of building suppliers and Home Depot (NYSE:HD) so you can capture the existing home activity. The point here is that we are in a lower mortgage rate world and that could be tradable once things quieten down over the next week or two.

As a trader I expect you to decide what your entry point is. I would advise taking a phased approach in going long. If you want to use the "Buy-Write" tactic, then you may want to buy in 100 share units so that you have the short call balanced. I would still use a phased approach and hold off writing the call until you have your full position. If you want to use options more aggressively, I would suggest that your longs have an expiration date a bit further out than you normally do, and use a nearer date for the short portion.

As far as the ETFs are concerned, yes, there are points of overlap in the tech-related names. I think you should still take more than two, I would take all 3. I see the overlap as a strength since I really don't like ETFs and welcome the concentration. I just think it's the right vehicle for a trade, and if I am right, a nice pop to the previous high will pay off just fine.

Get off the sidelines and go long

I want to sum up by saying that we may fall today, or tomorrow, but those drops should be bought with the faith that the support will hold. What the torrid bounces are telling me is that this market wants to go higher. That thesis would be violated if we break this support level just established - 2820 to 2830. That said, people might very well be surprised with where the market goes next. Most surprised will be the bears.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.