Beware The Bull Trap

Bull Trap

So, it turns out that the $15 puts on Ford that I discussed surged in value. On Thursday, Ford Motor Company (F) shares plunged to as little as $14.57 at the lunch hour. Then, the market turned on a dime, and Ford stock popped back to $15. Buying opportunity for Ford and the rest of the market? No… not yet. Don’t fall for the Bull Trap.

As I’ll explain, the market’s negative momentum dictates that institutional capital is pulling toward the sideline. But just a little bit of short-term buying or short-covering can create little rallies known as “Bull Traps.”

Today, I want to highlight what you need to know, and why shorting Ford is a better bet right now than going long. But, again, it all comes down to probabilities and understanding momentum. 

The Bull Trap and Technical Stair Steps

As I noted, momentum turned negative on Tuesday after a steady outflow of capital dating back to April 1. However, if you look at this SPY chart (The ETF that tracks the S&P 500), you’ll see that the index uses its 20-day moving average as bottom-line support for an upward move dating from March 16 to March 30. 

This rally was rather incredible. And it fueled a dramatic reversal that started on the first. 

Now, I’m not drawing channel lines that show upward and downward support. But you can see as the market climbed during those two weeks, we saw higher highs and higher lows. The market continued to find support during selloffs and would take another leg up upward. 

Once momentum turned negative earlier this week, we saw the opposite. Lower highs and lower lows. And those lower highs are what tend to define a “Bull Trap.”

A stock or index can break above one of the defined support levels and signal that it’s time to buy. However, what can happen is that a short-term rally is a reason why many people come in off the sideline, only to be trapped. Their buys can fuel a loss pretty quickly as the market reverses and follows its ladder-down step pattern. 

Back on January 13, market momentum went negative. I circled it on the chart with the skills of a kindergartner…

As you can see, there are multiple upward blips along the way down. See the red arrow, also drawn with toddler-like skill? Those are little bull traps along the way down. 

Momentum Swings Set Up Bull Trap

Momentum didn’t go positive again until around January 28, when the insider buying/selling ratio was at its most substantial level since March 2020, according to SECForm4.com.

When momentum goes negative, it can and should take capital a lot of time to move off the sideline and back into stocks. We’ve seen over the last week that just a little bit of volume can drive stocks up in a short period. Unfortunately, this weak volume REALLY means that many retail and institutions are not interested in buying too many stocks. 

The value of measuring broad market momentum is that based on volume and price movement, it is an excellent time to move in off the sideline. Add that to a strong insider buying/selling ratio (a measurement of what company executives do with their own money). You can take confidence in buying back into the market. 

The weakness in this market is especially pronounced by selling pressure in the Mega Cap stocks today in Meta Platforms (FB), Amazon (AMZN), and even Alphabet (GOOGL). All are fine long-term investments, but if you’re looking for an entry point, remember that you’ll be able to buy for less if momentum remains negative.

I’ll let you know when the momentum is bullish once again. But, for now, exercise patience and remember that cash is your best friend. You do not want to get caught up in a Bull Trap.

A Quick Word on the Fed

As I noted yesterday, we lack enough data on the Fed’s quantitative tapering program. As a result, we can only go on the Fed’s previous tapering efforts to estimate what the future might hold. 

The central bank announced that we’d see a VERY aggressive liquidity reduction by the Fed in the months ahead. It will be EVEN FASTER than what transpired in 2018. The Fed ramped up its monthly reductions to $50 billion over nine months. 

In this case, it will ramp them up to $60 billion in just three months. As a result, we’ll also see a reduction in mortgage-backed securities and far more rate hikes than expected. 

In 2018, the S&P 500 experienced a decline of about 6.5%. However, it’s important to remember that the final month of the year experienced a peak to trough decline of nearly 20%. 

I cannot tell you if or when that sort of decline will occur. However, before March 2020, that was the most significant downturn for the market over the previous decade. It appears to have been directly linked to Fed tightening AND a major geopolitical event around tariffs. 

In Conclusion

Given that we have major geopolitical events, generational inflation, a gauntlet of overpriced stocks, and a Cape Shiller S&P 500 ratio higher than most of the downside of the Dot-Com bubble, I urge extreme caution. 

If momentum goes negative (it’s negative now), I like to hold as much cash as possible. A 2018 downturn would come AFTER I receive a signal, and while we might experience a few percent loss, “moving to cash” and waiting it out is far better than trying to time the bottom. 

I hate to lose more than I like to win. That’s why I focus so much on playing defense in the markets. And it’s why I follow institutional momentum and insider buying like a hawk.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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