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The past few weeks have brought a dramatic change in investor sentiment. After months, if not years, when risk assumption far outweighed risk aversion, that equilibrium has shifted dramatically in recent weeks, threatening the increasingly popular strategies of buying dips and chasing momentum. While they remain time-tested trading techniques, traders have gotten an unwelcome reminder that no strategy is foolproof.
This is not an indictment of dip-buying, per se. As we wrote last week:
Let’s be clear – there is absolutely nothing wrong with buying on dips. It certainly fits with the concept of “buy low, sell high”. I imagine that there were speculators in Mesopotamia or ancient Greece who bought grain or other commodities when prices fell; why shouldn’t modern traders do the same?
That piece was entitled “Buy-the-Dip” Gets a Stiff Test. The S&P 500 dropped by -1.71% on Friday, and by Monday, pre-market futures were rising by 0.5%. We had seen pre-market rallies fail in recent sessions – including a very modest one just ahead of last Friday’s big drop – so we viewed Monday’s early bounce as traders reflexively buying dips than a considered decision that Friday’s move was unwarranted. The early bounce was proven to be reflexive and hopeful, rather than considered.
It would be one thing if we saw that type of reflexive bounce sporadically. But instead, it occurred with regularity and unsuccessfully. Bearing in mind that during the past five sessions have seen pre-market bounces even as SPX ultimately fell during four of them (-1.71%, -0.50%, -0.47%, +0.01%, -1.59%), traders who chased those fleeting bounces should have tried to take note that the follow-throughs were not arriving as hoped. Perhaps Brian Fantana, Paul Rudd’s character in the film Anchorman, said it best:
They’ve done studies, you know. Sixty percent of the time, it works every time.
Ron Burgundy knew that it didn’t make sense, and so should everyone else. It is a fallacy to believe that a particular market tactic works flawlessly, even if it does have a great track record.
Another strategy with a great track record that has failed recently is trend following. There have been numerous examples of high-profile stocks that had solidly persistent trends that reversed painfully. These include Meta Platforms (META), which gave back about 2/3 of its 20-day winning streak; Palantir (PLTR), which has regressed fully to pre-earnings levels after a 50% run-up; Hims & Hers (HIMS), which had a stellar but brief surge; and of course Tesla (TSLA), which more than doubled after the election and has since given back nearly all those gains.
These examples (charts below) are not meant to imply that trend-following is an undesirable strategy. Quite the opposite. But like dip-buying it is far from foolproof. One needs to recognize that trends can turn suddenly and unpredictably. In either case, traders should always manage their risks assiduously. Stop-loss orders and the like, which are themselves not foolproof, mind you, can go a long way to preserving gains or at least minimize losses. There’s never anything wrong with attempting to minimize one’s risks, no matter how aggressive or time-tested the strategy being utilized.
META 2-Months Daily Candles
Source: Interactive Brokers
PLTR 2-Months Daily Candles
Source: Interactive Brokers
HIMS 2-Months Daily Candles
Source: Interactive Brokers
TSLA 4-Months Daily Candles
Source: Interactive Brokers