Although you would never know it from looking at the Dow Jones Industrial Average (DJIA), the last few months have presented the most difficult market environment that many traders have ever encountered.
There are three aspects to this situation. First is that the stocks most traders favor have collapsed. Late last year and early this year, traders experienced a fantastic environment in which stock picking and aggressive trading of secondary stocks were greatly rewarded. Sectors such as high-beta growth, special purpose acquisition companies (SPACs), electric vehicles, solar energy, lithium, biotechnology and gambling and gaming were producing great momentum.
In mid-February this speculative action came to an end, and many stocks have been trending down and have fallen into a bear market since then. Two easy ways to see how bad it has been for much of the market are the ARK Innovation ETF (ARKK) and the iShares Nasdaq Biotechnology Index Fund ETF (IBB) . Those charts represent what most traders have been dealing with recently.
That action is not unusual. It is a normal corrective cycle, but what has made it far more difficult is that strength in the major indices created an expectation that the secondary names would bounce back quickly. However, liquidity has continued to flow into names that are typically favored by big funds and buy-and-hold investors. Those big-cap names keep driving the DJIA and S&P 500 to new all-time highs while other areas of the market continue to drop.
Casual market observers will have no idea how poor the trading action has been under the surface. The thing they don't recognize is that individual traders simply don't tend to focus on the sorts of names that are pushing the indices to new highs. Very few traders even look at stocks such as Honeywell (HON) or Dow Inc. (DOW) .
The third aspect of the difficult trading environment is that fundamentals, valuations and good stories don't matter for the stocks that are under extreme pressure. That is pretty typical of bear market action, but in contrast there are some parts of the market at the other end of the spectrum. Stocks with little growth are being rewarded with exceptional multiples primarily because they are in value sectors that are seeing inflows.
It is tough out there for traders and even tougher because it is not at all evident in the indices.
So what do we do? First, we have to recognize what is going on. The stocks that most traders favor are not working, so it is important to not force trades and to wait for conditions to change.
Do we start chasing value stocks and other names that are seeing relative strength? That may work for some, but typically traders do not do well when they try to radically change their trading style. It is important to look at those stocks that are working best and look for setups within that universe, but trying to reinvent yourself as a long-term, buy-and-hold value investor is going to be a very difficult process.
We have a gap-up open at hand here on Friday morning as the senior indices build on Thursday's bounce, but it was a miserable day again for growth and many speculative small-caps. Many stocks are grossly oversold, but that doesn't mean they are going to produce sustained bounces.
Stay patient and embrace the fact that this is one of the toughest trading markets you will ever experience.