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Dear Fellow Trader,
It must be odd to see the S&P 500 peel higher today, while momentum turns sour. Although NVIDIA Corp. (NVDA) rallied another 30% at one point Thursday, we now have a situation where the rest of the market remains under deep pressure.
Today, 64.4% of stocks were under their 50-day moving average; 64.8% were under their 200-day moving average. The number of stocks hitting new 52-week highs hit 327. And all of them are in the industries that will take a big hit from a recession. So, today, I want to remind you about how momentum works in this environment. And why - as momentum turns negative - it's important to take shots at the underperformers.
As we know, stocks hitting their lows tend to move higher...
So let's dig in...
It's a Mad World
If you read the news today, you'd think that only NVIDIA had reported today. But the way that earnings registered... Dollar Tree Inc. (DLTR) got crushed. Meanwhile, other major names in the tech space - like Snowflake Inc. (SNOW) - which I've panned - fell 18%. There's no "AI" in "SNOWFLAKE."
If we look across the market there remains significant pressure in key industries that are pricing in recession. I'm talking about aerospace, defense, agriculture, manufacturing,banking, farm products, packaged foods, and more. Consumer-defensives - especially higher margin products - are getting hammered. Price inflation will likely start to retreat in those products - and we could see a glut of inventory (And sales) very soon.
That said, take a look at retail apparel - names like Genesco Inc. (GCO), Children's Place Inc. (PLCE), Shoe Carnival Inc. (SCVL), and Victoria's Secret & Co. (VSCO).
If consumer spending is this bad now, imagine where it will be in just a few months. These stocks are getting hammered, and no one wants to step in and bid. Even the executives aren't spending their own money on these names. What does that tell you?
If the insiders aren't buying... then they might foresee a move lower.
How to Trade Weakening Momentum
The best way to trade these names - without short selling - is to buy in-the-money, short-duration puts on these names which aren't trading at high levels of volatility. We want to tap into these names with a targeted price, so consider doing a put spread.
In the case of a company like Gap Inc. (GPS), shares fell 3% on Thursday. A trader might consider buying GPS June 9, 2023, $8.00 put (around $1.05), and selling a put for the same expiration date at $7.00 ($0.50.). By selling this spread, you define your risk and reward in a trade, and also have a breakeven level that is higher than the current price.
If the stock - at any point - moves up to $7.60, you just cut the trade, preserve your cash, and take about an 11% loss... which is good risk management. But if it keeps moving lower, you can tap into that negative momentu…
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.