The purpose of this post is to explain why and how I shorted the S&P 500 on Jan. 6. In an earlier post, I described the two methods I use for detecting “tops” or, more precisely, local maxima. I also said that I don’t trade this signal. In fact, since I use a countertrend strategy, I will be taking long swing trades all the way down.
The chart below shows SPX going trendless in early December. You see ADX(14) < 20 and you also see SMA(10) go flat. There’s a crazy ramp at year-end, and then SMA(10) resumes flat. I reasoned that many investors were holding off selling until the new tax year, so I ignored the ramp. This theory is supported by the low volume.
The other method is to count distribution days. I posted this next chart on stocktwits, last Thursday. By that time, I was very surprised the IBD hadn’t registered “under pressure.” The chart shows daily volume, and it also shows Chaikin’s money flow, a handy way of evaluating up and down volume.
Peter Brandt said it best. Chart reading doesn’t enable you to predict the future. It enables you to take trades with favorable risk reward. In this case, I could set my stop 1% away at “new all time high,” against the possibility of a prolonged decline.
The other issues I might have chosen to short, QQQ and IWM, were already more than 1% off their peaks. The Russell had peaked earlier (another tell) on Boxing Day. Speaking of Canadian holidays, last week I posted my approach to currency hedging. Instead of selling SPY short, I bought SH, the 1x inverse ETF. The market usually moves opposite to the USD, so my negative USD position is a hedge.
I might also have bought SDS, the 2x leveraged ETF, but then my stop would be 2% away. It’s confusing enough having to remember that my mental stop to cover SPY at 184.69 is really to sell SH at 25.22. Happy new year!