Financial markets are like waves that go up and down. The secret to success in this industry is recognizing those waves, identifying when they ebb and flow, and anticipating when the tide will change.
This metaphor isn’t overly stretched; the fact of the matter is that assets tend to go up and down in the short term, with many of those changes being random and impossible to predict. The emergence of high frequency trading and algorithm-driven trading systems means individuals cannot anymore compete in predicting short-term security price movements—at least not in the world of common stocks. While technical analysis is still taught in the CFA curriculum and has a very limited place in financial markets, technology has largely displaced the technical in financial markets.
So where does that leave us? An emergence of swing trading has quietly taken hold in institutional investment circles over the last twenty years, with analysts and investors trying more to anticipate changes in the next 3 to 6 months instead of trying to anticipate what will happen tomorrow. This is much easier done, and can be done with a firm conceptual grasp of financial markets, underlying securities, and investor sentiment.
To demonstrate this, let’s first take a look at Twitter (TWTR), which jumped over 10% and then faded slightly to close up 7.9% after announcing earnings on Wednesday. This was thanks to a small revenue beat and a big EPS beat, although neither helped as much as the DAU and MAU metrics, which were a lot stronger than expected.
However, it’s important to keep in mind that Twitter still saw its revenue fall by 7.8% although it’s in a high-growth sector and is still priced as a high-growth stock. But the stock has fallen sharply from its all-time high of over $70 and much lower than its IPO range in the 40s; in fact, TWTR shares have been hugging the teens range for months despite beating on earnings every quarter and missing only 3 of the last 5 quarters (and those misses were after the secular price decline).
So what gives?
Here we clearly see TWTR temporary hitting a bottom and investors pounding into the name at the sign of any good news. The slight beats and the strong user metrics are good news enough to help the stock see a short-term burst.
Similarly, investor sentiment has moved in waves when it came to Snapchat (SNAP), which IPO’d over $20 and jumped to $27 in a couple of days. Then it tumbled to less than $20 only to bounce up again into the 23 range and then dip again to the low 20’s. Interestingly, this movement is in a relatively tight range—about 15% from the midway point in both directions, which is nothing for a recently released growth stock with few metrics made public. Now investors are eagerly awaiting the May earnings release and whatever data they will get from the company—and the price will reflect how the market is feeling about what that event will uncover.
Now let’s switch to a third and particularly interesting display of this wave-like pattern: financials. Looking at the Financial Select Sector SPDR (XLF) over the last two years, we see the up and down pattern with a sudden sea change in November. That sea change was Donald Trump, and anyone who predicted it could quickly make a lot of money very easily. Few did, of course.
Before that, financials were a dog. The financial press kept talking about job cuts in the industry and the transition of banks from being more like a product-producing firm to more like a utility—something that is boring, predictable, and necessary for modern civilization. Suddenly any price-to-book premium and P/E ratios over 15 seemed absurd, which kept XLF down throughout most of 2016, with a few run ups when the stock fell too low.
Then Trump became president and everything seemed to change. “A new paradigm” was the majority view, and XLF soared over 30% in weeks. Then it peaked in the middle of February as America’s new president struggled to get much done—and perhaps some questioned the wisdom of what he wanted to do in the first place. Then financial firms like Goldman Sachs (GS) posted disappointing earnings and revenue—not because they numbers were bad, but because expectations had gone so high.
With that, XLF is down 3% from its peak just two months ago.
What is the lesson in these three examples? Swing trading can work, it can be profitable, and it is increasingly becoming a source for alpha. But it requires intense research and very close scrutiny of investment opportunities as well as a good macroeconomic perspective. That’s a lot of information to consume all at once, and a very difficult task of synthesizing it all into a coherent model that will be predictive.
But right now, that’s how you’re going to make a market-beating profit in stocks.