We might be at a very important juncture in the markets. So I thought it would be a good idea to write more about how I try to gauge sentiment and ultimately how I try to determine if it makes sense to have exposure to markets or if risk has increased to a point it is better to step aside and move to the sidelines.
I highly recommend Charting Your Own Equity Curve. It comes down to being able to analyze risk in a much better way as it takes into account your own personality. After all your own equity curve is a direct reflection of what you trade and how you trade.
Some clues and insights you can gain from dissecting the information your equity curve generates:
- What’s the maximum drawdown?
- Are you underperforming or outperforming the market?
- Is there any correlation? Does your equity curve look like the S&P 500?
- What about the overall volatility? Smooth character vs. erratic trading personality.
- How does your equity curve look like? Does it display Strong Chart Character Traits?
The list goes on and on but I’ll leave it at that. So, what kind of insight did I gain from watching my own equity curve over the last 4 months?
The most important thing I am paying close attention to, is if my equity curve chart meets my expectations. Put another way, I look at the chart as if it was a regular stock. I look for specific patterns, monitor pattern pressure and analyze what the odds are for the chart to break out to the upside at specific moments in time. As with stocks the conclusion is always the same. When my expectations for moves to the upside are met or exceeded I have nothing to worry about. When the exact opposite happens it is time to worry and think about changing my mind. That could mean not putting on additional trades, reducing my overall exposure or outright going to 100% cash.
My own equity curve was setting up for a break out to the upside. Today it fell down to its moving average 20. Overall the chart still looks great but somehow it doesn’t feel ‘great’ anymore. The chart somehow looks tired and has basically gone nowhere for roughly 6 weeks. I am up about 50% since I started trading back in October so I have nothing to complain about. But what the chart now lacks is immediate pattern pressure to the upside. It definitely is not the end of the world, but the next few days will tell me if I need to take a step back. Maybe the trading environment is not conducive to my position trading style anymore. When I say ‘trading environment’ it really comes down to the following things I analyze:
- My own equity curve
- The results of my daily scanning
- The overall market i.e. the S&P 500
- The number of stocks with sound bases and strong pattern pressure
- The ‘feeling’ I derive from clicking through hundreds of charts every day
I am starting to see the first cracks. Lots of stocks look very extended, there are still lots of great set-ups out there but they are getting harder to find. Stocks are now starting to react to bad news, something they shrugged off in recent months. APKT – Acme Packet, one of the stocks I use to gauge the market’s health, doesn’t look like it wants to put in a short squeeze anymore. FFIV – F5 Networks another market leader is getting killed in after hours trading.
The next few days will be telling. I am not sure yet what I will decide to do. This is not the time to be a hero. If my portfolio positions act well I am willing to be patient. If we get a series of brutal down days like today I will consider reducing my exposure and might even consider going to cash. My own equity curve will be my guide. For now everything looks fine and the trend is still up, but if it starts rolling over there is no point in fighting either my own equity curve or the overall market trend. Keep in mind trading should be effortless. The biggest percentage of one’s performance usually comes from correctly aligning with the prevailing trend as opposed to being a good stock picker.
The right thing to do never requires any subterfuge, it is always simple and direct. – Calvin Coolidge
Investing in your education always pays. Learn how to read chart patterns like a pro!
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