• Trading Myths Revealed

    by  • December 7, 2012 2:45 pm • Quick Hits • 1 Comment

    As 2012 winds down, it is always fun and worthwhile to reflect on what we learned.  A few things stood out to me, but the most interesting is what I’d call trading myths.  In fact, if you followed these myths you probably had a rough year.  Now without further ado, here are the top trading myths of 2012 revealed.

    Myth #1 – A ‘low’ VIX is bearish.

    We’ve heard a lot this year how the VIX is low and this is bearish.  In fact, when it gets down beneath 20 or so we start hearing a lot of talk the VIX is low and this is complacent, and this will lead to a spike in volatility and lower equity prices.  What you need to be aware of is we’ve seen the VIX trade beneath 20 for years!  For multiple years each of the past two decades we’ve seen the VIX stay ‘low’ for a long time.  And the funny thing is we never saw a crash during those years, in fact, we saw some pretty impressive gains.  As Bernie Schaeffer pointed out recently, the biggest market disaster this year was how wrong the crowd has been on betting on higher volatility.

    Given we just had another record spike in call buying, it appears the same fears that have been in place all year are still in play.  If you are a contrarian at heart, this bodes well for potentially another long period of a ‘low’ VIX coming soon.

    Myth #2 – Low volume is bearish.

    This is an argument I’ve heard the bears make for over three years now.  In fact, I remember doing bull vs. bear debates the second half of 2009 and like clockwork you could expect this one to come up.  Interestingly, not much has changed, as just last week I saw an interview and the guest was concerned with the ‘lack of volume as confirmation’.

    First things first, of course volume is ‘lower’ now than what we saw during the financial crisis.  You’ll always have more volume during a crash than the recovery.  It isn’t fair to compare the two in my opinion.  At the same time, we have a generation that simply wants nothing to do with stocks.  The constant outflows from equity mutual funds and lack of interest in a huge bull market confirm this.  So less participants probably means less volume.  Also, there aren’t nearly as many hedge funds as there were just a few years ago, so again, less volume just makes sense. Then, considering some of the issues we’ve seen from the high-frequency trading (HFT) crowd — think Knight Capital Group Inc. (NYSE:KCG) here — and again, less volume is totally logical.

    But the biggest reason we are having ‘lower’ volume on this bull run is because stocks are worth more.  Remember, it was a lot easier to buy a whole bunch of BAC with it was down around a buck than trading AAPL when it is up over $500.  I don’t remember the exact breakdown, but there were days at the depths of the crash when C would account for a huge portion of the overall daily volume.

    If the most popular names today are up over $100 (AAPL, CMG, GOOGs of the world), then again how can anyone be surprised volume is light?  To prove this point, we broke it down by something we called total-dollar volume.  This is simply a stock’s dollar volume times its actual daily volume.  Breaking it down by all the components in the SPX we found that volume on this recent bull market is actually HIGHER than during the ’03-’07 bull run!  Um, that right there kind of puts a real thorn in the side of bears saying volume is ‘light’ this time around and that is somehow bearish.

    Lastly, total option and futures volume made a new record in ’11, but are down some this year.  My take here is the only traders left are more sophisticated.  They have realized you don’t have to trade just stocks and have moved to other areas of trading, versus simply buying and selling stocks.  Heck, take another look at the record VIX call activity from Myth #1.  Maybe instead of buying stocks, investors are just buying volatility anymore.

    All in all, I haven’t bought the whole ‘low volume is bearish’ argument for years and I’m not about to start.

    Myth #3- Fundamentals are all that matter.

    Do they matter?  Of course.  But if this year has taught us anything, it is sentiment coupled with price action might matter more.  Case in point, Germany’s stocks market is up about 30 percent year-to-date.  Does anyone really think the German economy suggests gains like that?  Of course not.  Germany’s GDP is expected to grow less than one-percent this year!  If that is all you looked at, you’d have no clue their stock market is as strong as it’s been.  The reason it is this high is because sentiment toward Europe in general got so over-the-top gloom and doom, that any good news this year has lead to a huge rally.  Remember, a year ago at this time all the talk was Greece was going to go bankrupt and take down the rest of Europe with it.  Of course that was a little off and now the solid gains are all we have to show for it.

    Look at housing in the fourth-quarter of last year.  Housing stocks had a rough ’11, but began to show signs of life late last year.  In fact, housing was one of the top performing groups in the 4Q of ’11.  Check out the outperformance starting in early October.

    Even after the strong end of year, the majority of market participants hated housing.  The general thinking was there was no way the stocks could keep going higher.  In other words, expectations were about as low as you could hope for and for this reason we made housing our favorite sector for ’12.  Remember, it is all about buying expectations, not prices.  The news on housing came out most of this year and it wasn’t’ great, but it sure wasn’t as bad as was predicted.  This lead to some major buying.  It wasn’t until just the past month or so that we have started to really see a change in sentiment toward these stocks.  With most up over 50% and some close to 100% on the year, now analysts are bullish!   Funny how that works isn’t it?

    Myth #4- The market is rigged.

    Hedge fund and insiders have all the info needed to be successful.  The small guy simply can’t succeed anymore.  Well, you could argue part of this is true, because back in September the SEC charged the NYSE with a violation of prop feeds to proprietary customers before it went to the public.  In other words, they were giving data to the big boys before the public was getting it.

    Now what’s important to know is that is for the very short-term traders out there.  I’m more of a swing trader and would agree that with all the HTFs out there, short-term trading is very tough.  Josh Brown put it best when he said “In order to beat high frequency traders, you have to be a low frequency trader.”  I think that really nailed it.  I’m not a huge ‘buy and hold’ guy, but buying and giving something time to play out is one way to avoid the crazy intra-day volatility on some stocks we’ve been seeing.

    How can you beat the hedge funds you ask?  Well, for starters you can look to see what they are doing.  I’ve talked a lot about how short interest is one of the better intermediate-term indicators I’ve seen in a while.  I won’t get into all of that now, but you can read some of my thoughts here.  The reality is big institutions leave their foot prints and it pays to see what they are doing.  Keeping this simple, when short interest goes higher it is bearish and when it trends lower it is bullish.  Right now I see a lower trending short interest, with a lot of room to dip lower – a very bullish combo.

    Also, Todd Salamone has done a great job  this year in Monday Morning Outlook (our weekly market update) examining what the hedge funds and institutions might be doing in the options world and how you can play it.  Below is a chart he has been mentioning a lot lately.  It is a put/call ratio of buy-to-open data on the SPX, QQQ, and IWM.  Again to keep this simple, it is very low.  Our theory here is this suggests hedge funds and institutions are drastically underexposed to this market.  How can that help the average trader?  Well, we think that means there is still plenty of money on the sidelines and this could push the overall market much, much higher eventually.

    Myth #5 – You can’t trust anyone anymore.

    For a market that isn’t too far away from new all-time highs, the level of distrust is incredibly high.  Of course, this is one reason why we remain in the longer-term bullish camp.  None the less, there are some people you can trust out there still.

    Here at Schaeffer’s we do our best to give an unbiased look at the world.  If you’ve at all followed what Todd Salamone has talked about in Monday Morning Outlook, then you know just how well he has done this year.  From calling peaks, to nailing bottoms, he has done a tremendous job of navigating the markets using various sentiment-based indicators others simply don’t follow.  You can follow him on Twitter here.  The always enjoyable Adam Warner is another one to follow and learn from.  He has forgotten more about the VIX than most of us will ever know.  I’m not a bad guy to follow either, so I’ve heard.  Of course, you can follow our company Twitter handle here to see what we as a group are watching.

    Lastly, you can get a list of all our traders here at Schaeffer’s on our new Schaeffer’s Trading Floor blog.  This is a new website we created especially for the traders here.  I like to say it is by traders, for traders.  We do our best to give honest opinions with little to no bias.

    So there you go, some of the biggest trading myths of 2012.  Feel free to comment below and let me know what you think.


    One Response to Trading Myths Revealed

    1. reformedbroker
      December 11, 2012 8:12 am at 8:12 am

      Awesome post, so much information, thank you!

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