Tuesday saw bears send a shot across the bow. In some instances, it may have been a shot into the bow. Damage was done, trends were broken, and bulls are left wondering if the glorious uptrend that began 2023 is destined for complete failure.
The headlines are blaming the steep decline on rising interest rates “rattling” investors. As well they should. The ten-year yield (TNX) has gone vertical as the bond market has decided to price out the recession and lower rates that were, just last month, thought to be inevitable.
Well, never mind that. Inflation is sticky don’t ya know and now its rates are higher for longer. I know, I know – that’s always been the Fed’s mantra. But before the market didn’t believe them. Now they kinda do.
But about that support break (see $405 in SPY). Should we care about it? The answer is, “it depends!”
Traders who follow the daily trend of SPY and use it to guide their trade and portfolio management certainly should care about what happened on Tuesday. Before it, SPY was in an uptrend and bullish. Now, SPY is in a daily downtrend. If that doesn’t warrant some kind of downgrade then you’re not trading off the daily time frame.
It’s as simple as the following:
When the market breaks resistance, I get more bullish.
When the market breaks support, I get more bearish.
Here’s what that would have looked like over the past few months. Resistance breaks are in GREEN since they’re bullish and support breaks are RED since they’re bearish.
I don’t know about you, but it seems like paying attention to these support and resistance breaks has been a good idea. It’s certainly helped indicate when the balance of power shifted from bulls to bears and vice versa.
What Downgrading your Bias looks Like
If you weren’t leaning all that bullish before Tuesday’s support break, then you may not need that much response. If the number of bullish positions and the corresponding delta exposure were only mildly bullish, then your response may have been muted.
But let’s suppose you had enough exposure to warrant a downgrade. What does that look like?
Fundamentally, you have two options for reducing bull exposure/increasing bear exposure.
One) Exit old bulls
Two) Enter new bears
Two ways to decrease exposure
If you aren’t all that comfortable with bear trades or lack a good track record with them, then you may favor the first option over the second. Determining which bull trades to bail on is more art than science but here’s my personal pecking order. This is listed from easiest trades to exit to hardest.
- Trades near profit target
- Trades at breakeven
- Trades partially profitable
- Trades with a small loss
- Trades with a larger loss
Note that this list focuses primarily on where the trades sit from a profitability perspective. Consideration must also be given to the chart. For instance, if a trade is at breakeven but the chart still looks great then I may prefer keeping it and instead exit a trade that has a small loss and a bad chart.
What About Hedging?
A third option is to hedge bull trades. Perhaps you don’t want to get out of your position altogether but rather want to reduce your exposure. That’s where adding a hedge come into play.
One) Exit old bulls
Two) Enter new bears
Three) Hedge old bulls
Three ways to decrease exposure
I tend to use the hedging route on core positions that I want to always own in my portfolio. Exiting them because the market breaks a short-term support level would be silly and result in me getting shaken out of my positions all the time. But that doesn’t mean I can’t temporarily reduce the risk while the adverse winds blow. Here are some common hedging techniques used on various positions.
Position One: Long stock. Hedge: Sell calls to convert to a covered call
Position Two: Covered call. Hedge: Roll down your call to a lower strike price to bring in more premium/protection
Position Three: Naked Put. Hedge: Sell calls or call vertical spreads (aka bear calls) against it to convert to a short strangle or jade lizard.
Position Four: Bull Put. Hedge: Sell bear calls to convert to an iron condor
Position Five: Long calls/ Bull Call spreads. Hedge: I find both of these too challenging to hedge. Exiting is usually simpler.
With time and experience, you’ll discover which techniques you like best.
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