The dangerous day does not look dangerous.
Most traders size up risk by looking at the number in front of them. The market is down 1.5%, so the risk is 1.5%.
That feels like common sense. It is also exactly backwards, and learning why is one of the most useful things you will ever do for your account.
Here is the idea.
The risk you can already see is priced. It happened. It is sitting right there on your screen, and the market has dealt with it. The risk that should worry you is the one nobody is looking at yet.
Let me show you what that looks like.
Picture a morning like today where the S&P is down a percent and a half and the Nasdaq is off 3%.
Scary, right?
Now look under the hood at the advance-decline line, which simply counts how many stocks are going up versus down. On this kind of day it can be positive. More stocks up than down, while the index bleeds.
Fifteen years ago that combination would not have made sense to me. Down a percent with a positive advance-decline line? What are you smoking?
But it happens now, and when it does, it is not the all clear. It is the warning.
Because it means only a handful of names are getting hit. The other 50 are fine, for now.
The whole thing is a game of musical chairs.
Everybody is dancing, rotating from one corner of the market to another, and as long as the music plays it looks healthy. You had better have a seat picked out for when it stops.
I have seen the music stop before.
Back in 2000 and 2001 it started exactly like this.
Horrendous rotations. Every day the Dow would be up 200 or 300 points and the Nasdaq comp would be down 200 or 300 at the same time.
Retail was shoving money into Dow names and dumping anything that lived on the Nasdaq.
If your stock belonged to that exchange, it got handed to you, plain and simple. The breadth looked fine right up until it did not, and then everybody sold everything at once.
That is the part to understand.
When the advance-decline line finally does correlate, when those 50 quiet stocks start getting sold together, that is not the end of the move.
It is the beginning of it.
So what do you actually do with this?
You stop reading the headline number as your risk.
You watch breadth. You watch whether the down move is contained to a few names or spreading to all of them.
You watch the sectors that are holding the whole thing up, because the day they crack is the day that matters. The 1.5% is not your problem. The 55 other things they have not sold yet are your problem.
None of this tells you to panic or to sell.
It tells you where to point your eyes. Most traders spend a down day staring at the loss. The trader who lasts spends it watching for the music to stop.
To your success,
Don Kaufman
P.S. This morning I closed out the 721/716 put spread in QQQ for a profit of 103%. These are the kind of opportunities we look for in Don-Dte.
