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It’s Happening (Your Six Rules for Negative Momentum)

by | Feb 21, 2023 | Market Outlook, Stocks

Here we go. Momentum signals have flipped again, and it’s looking like a selloff is in order. 

Everyone panic!

We’ll look for confirmation at the closing bell. But the threat of the Fed funds rate moving up to 5.4% is real. And it’s been something that I’ve warned about since… February 2022. 

Markets are not prepared for any significant uptick in rates from here. 

If momentum goes negative on our indicators and stays there… follow these six rules for negative momentum.

Rule 1: Cash Is My Friend

I move to cash when momentum turns negative. 

I know that sounds crazy. I sell everything? Well, I don’t sell everything in my retirement account. But my trading account? Yes… I move to heavy cash.

I’ve already made that move.

I’m mostly out of long positions in options, and I position my cash for buying opportunities. 

Since I’m an active trader and investor, I focus on key technicals that allow me to focus on new entry points. 

The move to negative momentum is very important as I protect as much capital on the balance sheet as possible. This is how I can buy for a dollar and sell for two dollars multiple times yearly.

Rule 2: Don’t Sell Puts, Unless… See Rule 6

If I find myself selling put spreads as an entry point, now is not the time for me to open new positions… 

If I sold previous cash-secured puts or put spreads, I entered this with the mindset that I was willing to buy the stock at a lower price. 

If I’m up on my current position, now would be a good time to take profits. 

If I’m down, now might be the time to assess whether I want to sell spreads at an even lower price.

When momentum goes negative, selling can be indiscriminate. That means nothing is safe. 

The last thing I would want to do is have exposure to a $50 put when the downside for a stock is much lower.

Rule 3: Learn Implied Volatility Rank

One of the great rules that I learned from my time with tastytrade and Tom Sosnoff was how to know the difference between cheap options and expensive options. 

I use a tool on tastyworks called Implied Volatility Rank (IVR). This measures the implied volatility of a stock TODAY compared to its IV during the previous 52 weeks of the year.

If a stock has an IVR of 25, its implied volatility is lower than the 75% of the trading days over the last year. 

If it’s at 80, that means it’s higher than 80% of the days in the last year. 

The general rule is that if IVR is under 25, it’s cheap to buy calls or puts. If it’s over 30, I might want to sell calls and puts. 

If it’s really elevated, that’s the time for me to do exotic trades like Iron Condors. This can also tell me which stock to trade and how to trade it compared to other ideas.

Rule 4: Sell Credit Spreads in Negative Momentum

If a stock is expensive to short with a long put, there are other “options.” I can sell vertical call spreads on stocks with a high IVR and benefit if the stock trades sideways or declines in value. 

I’d be selling someone the right to purchase a stock from me at a higher price. 

If the stock price falls, the underlying call will fall as well, thereby reducing the value of the call spread.

I use a higher call on the trade to protect myself against any surprise upside on a stock think a buyout or sudden momentum reversal.

Rule 5: Look for Oversold Levels on the SPY and IWM

Finally, the market tends to sell off fast and furious in negative momentum environments. 

From June 8, the S&P 500 ETF went from overbought to oversold in about seven trading days. 

Following the SPY’s move on the Relative Strength Index (RSI) to under 30, the market was oversold. Oddly enough, no one had the guts to buy stocks.

Want to know who purchased shares in oversold conditions and made a fortune? Robots.

Algorithms which have no emotion or fear – scooped up stocks in deeply oversold conditions and kept buying for a month. 

The market’s momentum didn’t turn positive for a month – until July 18 but low-volume buying produced terrific gains.

Rule 6: Wait… Sell Puts in Very Specific Conditions

The oversold territory is also a very good place to sell puts on stocks I want to own when we’ve reached a period of “peak fear.” 

If the RSI on a stock is at 25, and it’s a great blue-chip company, I use the high volatility and the fear to sell puts on a stock maybe 15% to 20% lower than its current level.

If the stock does fall to that point, I’ll have an absolute bargain. But if the stock does rebound from overbought, I can repurchase the option for less and pocket the difference. 

With that, I’m ready for battle. It’s time to trade momentum. 

To your wealth,

Garrett Baldwin

P.S. We’ve got a great lineup for tomorrow’s “Roundtable with Don Yocham.” The Fed could be nuking the market… and you need to know how to trade the threat of a 5.4% rate move. 

Also, there’s a lot of chaos happening in the agricultural markets. You know that I’m always watching the farms. With Russia on the brink of its next big offensive, something HUGE is about to happen in the food commodity markets. 

We have commodity expert Geof Smith breaking down the food supply challenges and how you can trade this massive story.

I’ll be watching because this might be the most important dinner table conversation of 2023. 

Geof will be joined by options expert Jack Carter to discuss the explosion in options trading over the last 12 months. 

It’s entirely free. Go right here at 10am ET for this live event: https://special.wealthpress.com/RoundTable

Market Momentum is Red

Let’s call it. This market is screwed. We pushed way into the stratosphere, and no one wanted to listen to James Bullard or Neel Kashkari. Now, there will be a lot of retail traders left holding the bag on crappy stocks like Virgin Galactic (SPCE) and ETFs like Ark Innovation Fund (ARKK). It’s starting. How far can this market move lower? Who knows. All I know is when it’s time to get out of the way.

WRITTEN BY<br>Garrett Baldwin

Garrett Baldwin

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