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Week 9: Buy high, sell higher
Welcome to Fifty Trades in Fifty Weeks!
This is Trade 9: Buy high, sell higher
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50in50 uses the case study method to go through one real-time trade in detail, about once per week. This Substack is targeted at traders with 0 to 5 years of experience, but I hope that pros will find it valuable too. For a full description of what this is (and who I am), see here.
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Update: Open and recently closed trades
Short NQM2 is just about flat (small underwater). Note: I forgot to do the position sizing exercise in 50in50 last week; I’m sorry. Micro NQ futures or short QQQ were fine for the trade but for retail traders, NQ futures are too large. I should have clarified that.
EWC long at 37.85 is doing OK currently trading at 40.40.
The May $60 XPO puts are worth about $1.40 (paid $2.60). Plenty of time left on the clock. XPO has come way off the highs and trades pretty soft. No change to the plan.
Today, I am going to talk about adaptation and why it’s good to avoid devoting yourself too religiously to one style of trading.
Good traders keep learning. They adapt. They want to improve every day and have a growth mindset. They don’t sit there and complain about how the market sucks; they identify new market regimes and try to understand whether their current process will work as the regime shifts. This ability to adapt has been especially important in the last 10 years as market microstructure has changed dramatically with the rise of the algos.
As trading was increasingly automated during the 2000s, there were two groups of traders: One group complained every day about the algos and how they were messing up the market and changing the game in unfair ways. The other group of traders analyzed the new market structure and adapted, changing their trading style to fit the new regime. Guess which group of traders lost their jobs?
When volatility, liquidity, microstructure, and correlations change, good traders see it happening and adapt their process. Those who do not adapt are eliminated by natural selection.
For the first 10 years or so of my trading career, I tended to favor mean reversion over breakout trading. This is often a feature of traders who fancy themselves as smarter than average, because the feeling of fading the crowd and “swimming against the tide” is something that can make you feel super smart. When it works.
On the other hand, reflexive contrarians get buried during major trends as positioning, sentiment, and price can move in the same direction for prolonged periods when the story is real and the narrative is strong. In big macro trends, you don’t want to be the smartest person in the world, you want to see the trend and ride it with everyone else.
That’s the underlying message of the various IQ memes like this one:
When it comes to independent thinking, Peter Thiel nails it with this quote (from his book “Zero to One”:
The most contrarian thing of all is not to oppose the crowd but to think for yourself.
Many traders are good in a specific type of market. Some are good breakout traders, or range traders or flow traders. Maybe they do well when stocks are falling but not when stocks rally. Some traders were great before the algos but have no idea how to trade algo-driven markets. The challenge is that markets are always changing. If you’re really good at one type of market, it is almost guaranteed that you will be a dinosaur at some point.
Don’t say “I’m a great breakout trader but I can’t do mean reversion.” Or “I’m a mean reversion guy.” Be aware that markets change and be the type of trader that adapts in real-time. Trade according to the empirical facts and the external setups and regimes, not a pre-programmed internal bias.
No trading method works always and forever. No matter how well your methodology works right now, there is a chance it won’t work tomorrow. Be vigilant to changes in the market and monitor the success of different trading strategies. For example, if you notice that breakout trading has not been working for you over the past two years, spend some time thinking about why. Has your methodology changed? Did you stop following your own rules? Or… Are there new algorithms doing the same thing you used to do, but faster? Are the basic breakout trading strategies such common knowledge that they no longer provide any edge?
A QUICK MARKETING BLURB
You should sign up for am/FX. That’s my daily global macro note, which I have been writing since 2004. In there, I explain all my live trade ideas (lotta FX, but also other asset classes) and give you all the global macro in an easily-digestible two or three-page note.
If you like what you are reading in 50in50 so far, you will love am/FX. It also includes a spicy nonsequitur each day to stimulate your brain jelly. Thanks.
END OF MARKETING BLURB
William Faulkner’s advice to fiction writers was: "Kill your darlings." What he meant was that no matter how much you love some paragraph or character or scene you’ve written, if it doesn’t work in the bigger picture: cut it. The same applies to trading strategies. Don’t be the trader that is a one-trick pony and can’t drop a strategy even though she knows (and the P&L shows) that it doesn’t work. Do not fall in love with strategies that made you money in the past. Kill your darlings.
Example: Traders that made money buying calls on WFH stocks before earnings releases in 2020 will have a hard time abandoning that strategy in 2021 or 2022. But it is highly likely that they should do so.
I tell you this from experience because, for the majority of my career, my bread and butter was trading lead/lag and correlation between currencies and variables like oil, gold, interest rates, and equities. This served me well from 2003 to 2013 or so, but since then it has been much more difficult to extract profit from this approach. Too many people know about the methodology, too many blogs post about it, and too many algos trade it.
In 2006, very few FX traders had live feeds for gold, oil, and single-name equities. Now every single trader does. In 2006 there might have been a few expensive, PhD-built algorithms trading correlation, now you can build a correlation trading algo in Excel in two hours and plug it directly into the market through an online broker.
Efficient markets eventually prevail. Always.
It took me a few years to transition, but now I use correlation more selectively and question the logic more aggressively before I employ it as a tactical or strategic decision-making tool. My first assumption now is to assume lead/lag will not work, and see if I can find reasons why it might work in this particular instance. In the past, my base assumption was the opposite. I’d assume it would work and then try to think of reasons it might not.
So I still use lead/lag… But my approach and assumptions have changed as the market changed.
If there is a major change to the structure of markets, STOP AND THINK.
How is this going to impact me? Here are a few examples of major structural changes that have changed markets in my lifetime.
1996: Currency market trading moves from voice brokers to electronic brokers.
2001: US stock markets stop trading in fractions and trade in decimals instead.
2002 - 2005: Algorithmic trading becomes an important part of most markets.
2010 - 2015: Flash crashes become an important liquidity risk in many markets.
October 2019: Free stock trading for retail traders triggers several euphoric "runnings of the bulls" in US stocks.
I believe that adaptation is one of the keys to survival and professional longevity in almost every industry. A good athlete adapts as her sport changes, just like a good trader adapts as markets change. Be thoughtful about the current environment, how it is changing and how it might change in the future. Think about how you can adapt your trading to stay ahead.
As the Red Queen in Through the Looking-Glass (Lewis Carroll) says:
Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!
You need to work twice as hard as everyone else if you want to get ahead. Understand the market regime and fit your trading strategy to that regime. Don't embrace a trading style and hope the market complies with it. “Trading style” should describe your time horizon, risk management approach, asset class focus, and preferred analysis methodology, it should not describe the specific strategies you prefer. Specific strategies work in specific market regimes and you need to adapt your overall style to the regime.
Don’t fall in love with the first thing that works for you and stick with it long after it stops working.
Trade 9: Long TWTR
Today Elon Musk announced that he has bought 9.2% of Twitter. Here is the reaction in the stock:
TWTR stock hourly since November 2021
If I saw this story and stock chart 15 years ago, I can absolutely guarantee you that I would be dying to short the gap higher because “it’s moved too much!” or “too far too fast!” or whatever.
Unless you have a specific measure for “too far too fast” that you like to use systematically (RSI below 10, for example)… The concept of “too far, too fast” is vague and useless in trading.
In this case, this is what I see:
Richest person in the world and wildly successful entrepreneur buying into a company that…
Has an excellent brand name but…
Has generally disappointed investors.
It’s a classic activist shareholder situation (kinda) and definitely not something you want to sell into on Day One. In fact, I think you plug your nose and buy it, despite the huge gap.
Reminder: This is an educational Substack. None of this is investment advice. The idea here is to share how I think… Not to tell you how to think.
The Elon Musk brand name is good enough to put a multi-day or multi-week bid under TWTR. Not to mention, Musk is an active and well-known user of the product and so his interest probably extends further than a simple pump of the stock. It looks to me like a classic: buy high, sell higher setup where the hard trade is the right trade.
I acknowledge that past pumps by Elon (Doge, etc.) have sometimes led to huge investor losses as the frenzy met gravitational reality much faster than longs could take profit. In this case, I think there should be another huge leg higher in the stock as the market slowly processes the new information.
The stock made a nice island today with 46.85 the low and 48.80 holding firm since about 10:30am. Here is the chart for today:
The risk management here is pretty simple. Buy the stock with a stop below $46, targeting $58/$68. I got the target by looking at the old equilibrium zone for the stock before it dumped. You can see that here:
Options don’t look particularly attractive compared to cash so I’m going to keep it simple. Long at 50.00 with a stop at 45.84 and take profit at 57.77. Risking 4.16 to make 8.52. Full details are in the spreadsheet here. As always, I will mark to market the trades at the point I hit send. So the entry point is at market; it won’t be exactly $50.00. It’s trading $50 as I type but could be better or worse depending on how long it takes me to finish writing and recording the audio!
The ability to both go with … or fade large market moves is a learned skill. As you grow as a trader, you should be equally comfortable jumping on a big move or going against it. Sure, most will have a built-in bias, but the key is to know your bias and overcome it in situations where you believe the market will reward you for doing so.
I think this is a situation where I should overcome my mean reversion bias and buy TWTR high in the hope of selling it higher.
That’s it for today!
50in50 goes long TWTR at 50.00 with a stop at 45.84 and take profit at 57.77
Note that for tracking purposes, I am using 1 contract of the micro NASDAQ future here as that’s the largest increment I can use that is under $2,000 of risk (standard risk unit of 2%). This paragraph was added the day after publication because I screwed up and forgot to write about position size in this article.
As always, I will monitor the performance and offer detailed updates as we progress. See you next week!
Thanks for reading.
Trade at your own risk. Be smart. Have fun. Call your mom.
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DISCLAIMER: Nothing in “50 Trades in 50 Weeks” is investment advice. Do your own research and consult your personal financial advisor. I’m putting out free thoughts for people who want to learn. This is an educational Substack. Trade your own view!