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Anatomy of a Fade Trade


Walking through a real-time financial thought process.

Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

I awoke this morning to a blanket of white on the East Coast; we're told this is the last major storm of the season, but predicting weather is akin to calling the stock market. Few can do it well, and we'll only know with the benefit of hindsight if real-time observations withstand the test of time.

With that said, it's been a busy day over on our real-time Buzz & Banter, and rather than recreate the wheel, so to speak, I thought it might be of benefit to share a few of the posts from this morning. Remember, we don't "do" advice in Minyanville-we feel that is disingenuous without knowing the time horizon or risk profile of our audience. We talk about what we're doing, how we're doing it, and most importantly, why.

My first Buzz this morning was titled, "Short Santa for a Trade"; I have nothing against Kris Kringle, mind you; I just like to have some fun with words in a business typically devoid of any semblance of creativity. I've included it below; the timestamp on the Buzz was 9:41 a.m. EST:

It's beginning to look a lot like Christmas -- or, that's the sense I get when I look out the window at the winter wonderland. Does that mean Santa is on his way? Yes; on his way out...

An old adage is that markets bottom on bad news and top on good news; today's NFP was great news (if you believe the numbers), and that adds an element of doubt to the upside rout.

Please note Goldman (NYSE:GS), JPMorgan (NYSE:JPM), Morgan Stanley (NYSE:MS), Google (NASDAQ:GOOG), and Amazon (NASDAQ:AMZN) trading lower out of the gate. We know that THE line in the upside sand for the S&P (INDEXSP:.INX) is up at 1580 but I couldn't help but fade (read: short) the opening gap for a quick fade trade.

As the market began to come in (read: retreat from the highs of the gap opening), I realized that just yesterday, in A Bird's-Eye View of the Stock Market, I wrote about "my desire to play more alpha (individual stocks) and less market (which is crowded), at least until such time that an advantageous risk-reward emerges (S&P 1580 comes to mind)." That triggered the following Buzz, "Anatomy of a Fade Trade," the timestamp at 10:41 a.m. EST:

I feel the need to clarify why I opted to fade (short) the opening through the S&P when just yesterday, I offered that until such time there is advantageous risk-reward in that vehicle -- and that wouldn't come into play until S&P 1580 or so -- I was gonna focus my energies on alpha, or individual stocks.

There are a few elements to this answer; the first was touched on earlier, but may not prove true: Rallies tend to end on good news, while sell-offs often end on bad news (or, in more familiar parlance, the news is always best at a top and worst at a bottom). I am NOT trying to call a top here, I'm just trading; so it's important that I don't "retro-fit" an axiom and fall prey to one of our 12 Cognitive Biases That Endanger Investors.

The simpler answer is that the tape is extended, gapped higher on the NFP, and the first thing my eyes spied were several large cap banks taking a five-finger sally across the cheek. Indeed as I write, Bank America (NYSE:BAC), Goldman Sachs, JPMorgan, Morgan Stanley, and American Express (NYSE:AXP) are down more than 1%. As go the piggies, so goes the poke? In some way, shape, or form, yes.

Here's the rub; S&P 1580 (or there about) is the level to lean against if you wanna make a meaningful stand, so laying out short-side exposure at S&P 1551 doesn't exactly provide nice and tight defined risk. While I can set my stop on this particular effort on the other side of today's high (near my entry), we're still in "no-man's-land" from a technical standpoint. But alas, there's more.

Technical Analysis 101 dictates that the time to buy a breakout is when it retests the level from which it broke out, or in current parlance, S&P 1525 and/or NDX (INDEXNASDAQ:NDX) 2750. As my chosen vehicle was the S&P, I've included a short-term chart below to demonstrate this logic. I'm not saying it gets there, mind you -- despite the lethargy in the financials, market internals remain 9:5 positive -- but if it does, that would be the level to cover up this trade.

Yes -- the short side remains the cute side above those price parameters (technical analysis is a better context than catalyst), but that's entirely OK; you can do anything as long as you're disciplined.

The trade remains open -- we're updating it in real-time on the Buzz -- but that's the thought process from someone who makes his living in the nuts and guts of the financial strut. Sometimes right, sometimes wrong, but always honest as we're apt to say, so we'll see how this puppy plays out through the rest of the session -- and whether or not I opt to carry home any risk, rather than take the time to enjoy my family, who I haven't seen since last Sunday!

Good luck, and have a great weekend!


Twitter: @todd_harrison

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