It’s fantastic for trades but you should consider a few guidelines.
By TIMOTHY COLLINS May 29, 2020 | 11:29 AM EDT
ongratulations, you’ve advanced to the Greater Fool market this week. Yesterday, I talked about alternatives and sloppy seconds. Today, we’re seeing some of those names hit levels that aren’t driven or supported by anything remotely fundamental. It’s one thing to trade or invest in a secondary name. It’s another when that name moves 20% to 40% in a single day.
That’s when you know the market has ascended to trades based on GFT (Greater Fool Theory). The concept here is you are buying 100% on the belief you can sell it to someone for a higher price. The thesis you can sell it to someone else is the totality of your decision making. Maybe, just maybe, the daily chart has some appeal with a price and volume spike over the last day, but often these are names that have done nothing for weeks or months and have no company-specific catalyst driving the price higher.
I’m not condemning this phase of the market. It’s fantastic for trades but you should consider a few guidelines.
Things are going to be volatile, so maintaining slightly smaller positions will help preserve the emotional capital you may burn watching PnL. Consider slightly wider stops because of the volatility. This is also why smaller positions work better. Those stops should be alerts, not limit orders. If you use limits, you’ll likely get stop run before a stock bounces again.
I believe scaling out of positions that are working is an absolute must. Scales need to be set based on personal risk and goals, but if you take partial profits as a trade runs higher (i.e., a portion at +10%, another portion at +20% or 25%) then you can get looser with your trailing stops and try to ride the momentum higher.
On the downside, don’t double down on losers. There are so many names running extremely well that losers are acting like losers for a reason. They may have a great fundamental story for the long term, but the short term trades are being driven by momentum. We’re talking about time frames here, specifically short-term time frames of hours to days, but nothing more than that. Many of the tiny names catching heat aren’t stocks you will likely want to see in your portfolio in July. Heck, maybe not even June.
The good news is we’ve moved away from an index only market into one where individual stocks are offering great opportunities. The bad news is we’ve seeing heavy speculation in some garbage names which means we should expect a return to volatility in the first few weeks of June.