Short Sellers Disappeared? Time to Short! (FAZ,C)

We’ve mentioned this a number of times over the last few years, but it bears repeating.  As we move toward the final, bull market, blow-off top, we expect to see price behaviors unlike anything we’ve witnessed historically.

 

And it will test all our markers, fundamental and technical, and very likely sentiment readings, too, which we fully expect to fly off the charts.

 

Why?

 

Because the final stages of a multi-generational bull market are not a rational phenomenon.

 

By nature, secular bull and bear markets always end with excesses.  But we’re now entering the mother-daddy of all bull market finales.  You will not see another market event like this in your lifetime, and your children and grandchildren may also never know anything like it, either.

Prices for financial assets – and very possibly tangibles, as well – will skyrocket in a fashion that confounds even the most carefree analysts.  Needless to say, conservative types, who rely on conventional numbers and traditional measures to signal entry and exit points, will get left behind, folding too early and closing out their best positions, even as those same securities soar stratospherically and deny them an additional 30%, 40% or 50%, and in some cases even multiples of those numbers.

 

And it’s with that in mind that we turn to today’s first chart, a paste-up of the latest NYSE short interest figures, which, as you’ll see, are now trending at their lowest level in three years.

 

Have a gander…

Now, again, we can’t say the current trend won’t continue for another month or two and push lower toward numbers that challenge records for the last decade.  No one can say.  At the ‘end’ it will certainly be the case; we’ll have complete and utter capitulation from the shorts.  But until that time, all we can be sure of is sharp fluctuations that make this latest decline look like grandma Beatrix bending down to pick her posies.

 

Financial Fecklessness

 

The short interest story is not exclusively a financials phenomenon, though as the next chart will demonstrate, the financial bears have been riven like kindling over the last two months.

 

Have a gander –

At the time of the financial crisis in 2008/2009, the financials were understandably the whipping boy of markets, and short interest on the sector ballooned as one would expect (left side of chart).  But over the course of the bull market’s following seven years, the shorts inevitably took off their trades and the financial sector rose.

 

Until Trump

 

Until the election, everything was still fine and frothy for those who considered themselves financial bears, but directly after, when an unexpected jump in prices squeezed a tremendous number of short sellers in precisely their most sensitive regions, short interest fell through a sink-hole (in green, above).  The buy-in forced the financials straight up, and now, the prospect of a correction looms large.

 

The question is whether the burned bears will have the bells to put on a new short, or are still overwhelmed by the fear they experienced in November.

 

For our part, the prospect of a correction in the financial sector appears inevitable.  We believe it’s likely to be short and sharp and that the ascent that began in November will resume directly afterwards.

 

Trading for a Living – II

 

We’re going to get back to our financials trade for the week in just a moment, but first we want to run down a few details in our ongoing series for those interested in trading for a living.

 

So we’ll start like this –

 

All trading is a process of minimizing risk.  This has to be remembered, because it’s the whole game in a nutshell, and it’s also the whole of your job every day as a full time trader.

 

Put another way, a trade that’s initiated without proper attention to a) system signals, b) proper money management principles, and c) psychology is very likely too risky an endeavor and will most probably fail.

 

We’re going to take a moment to look at the first of these principles of risk management today – in brief – before we wrap up with a blockbuster trade.

 

System Signals

 

No one ever made money without some regular parameters by which to trade.  There has got to be a system of some shape in place, and it must provide the trader with an edge over the market.

And that’s key.

 

Because there are countless systems on sale these days that will ensure you an 80% win rate.  But one important detail is left out: the losers result in catastrophic losses.  Or, if not quite that dramatic, the losers still take from you sufficient capital to render the whole system effectively worthless.

 

Bad system.  High risk.  No future.

 

There are as many different trading systems as there are trading personalities, and the best fit for you as a full-time trader must be developed from the tools you trust and the psychology you possess.

 

Psychology, of course, is a subject for another day.

 

We hope in the near future to run down a list of potential trading signals that you can employ to construct your own proprietary trading system.  Until then, stay tuned.  And watch how we do it.

 

Today’s Trade

 

We’re returning to the aforementioned financial sector for today’s initiative and using two securities to put on a long/short trade.

 

The first stock we’re using is Citigroup Inc. (NYSE:C), a financial giant whose shares have underperformed the rest of the sector of late, and whom we therefore believe will fall further than the rest in the face of continued market weakness.

 

The second leg of the trade uses the Direxion Daily Financial Bear 3x ETF (NYSE:FAZ), a highly leveraged security that rises disproportionately as the financials decline.

 

The trade involves selling CALLs on the former and buying them on the latter.

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Many happy returns,

 

Matt McAbby

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