I received the email below today. Great question. I thought I would share. I am sure others who read SMB Blog have had the same question. So please read the email below and our response.
Hi Mike,
I’m an equity trader at a hedge fund and read your SMB trading blog routinely and very much enjoy it. I’ve read your blog for a little under 9 months, and am curious how you factor in broader market moves into the stocks you trade (it seems like trades are very stock specific leaving out the ebb/flow of the broader market).
For example an example: stock XYZ has been very weak, topping out at 40. If the broad market is flat, the offer will hold and it’s a good short when considering risk/reward. However, there is a sudden surge of strength in the overall mkt which causes the stock to move above the 40 level, albeit not a violently as the overall mkt. In this case, would you a) still short the stock, hoping that the mkt will decline in your favor (whereas you could still lose money shorting an underperforming stock) or b) short the stock and buy Spiders to hedge, making money off of the relative performance spread?
This question comes to mind as the volatility levels in the market have grown exponentially. During less volatile times, specific levels hold fairly well. In this market, sudden momentum moves in S&P futures can easily break support/resistance levels of individual stocks, leading to whipsaws that chip away at PnL. Thanks for your time.
Regards,
John
SMB Responds
First, SMB trades a unique style. We are short term traders. We look for Stocks in Play. We do so because they offer the best intraday risk/reward opportunities for our trading style. Also, algorithms (trading programs) are unable to beat us when a stock has significant order flow. Second, there is more than one way to make money. But we believe that you should not pretend to be something you are not. We are experts in short term trading. We are experts in trading the Stocks in Play. So we stick with our expertise. Third, when a stock is in an intraday downtrend (“XYZ has been very weak”) we look for excellent risk/reward opportunities to short the stock. We short weak stocks. We do not get long weak stocks that are in a downtrend save a few exceptions. So if XYZ is in a downtrend, and 40 is offering resistance, we will short. If the 40 offer lifts because the market is strong, then we may cover. If the XYZ cannot hold above 40, it’s still in a downtrend, and the market strength subsides, then we will short again. Fourth, we pay special attention to longer term support and resistance levels for the overall market. And we pay special attention to longer term support and resistance levels for the stocks we are trading. During our SMB AM Meeting we discuss these important levels. A significant support level for SPY may cause us to cover XYZ and get flat. A significant support level near in XYZ may cause us to cover XYZ and get flat. Finally, Steve hedges a little.
SMB teaches multiple trading plays. For range bound markets our traders have arrows in their quiver. For volatile markets our traders have arrows in their quiver. To trade the many different markets I have seen and we will all see going forward one must be a well-rounded trader. But we ought to all stick to what we are good at. We ought to all try and get better everyday. And we should all be grateful that we get to compete everyday doing what we love.
Best of luck with your trading.
