Discipline Breeds Success

Welcome to Indicators and Insights. Every Friday, I write about what I find to be the key financial market topics, charts, and stories of the week, often challenging the conventional wisdom.

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Today I share my insights and a real-time example of how following a disciplined, rules-based trading model will protect you from your emotions and enhance your profitability.

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Those who are intimately involved in the financial markets on a daily basis know full well emotions can get the best of you. These days, it's not only due to the fear and greed that so often lead to extreme moves as the herd piles in on one, singular side of the market.

Emotions have been running inordinately high since the beginning of the year, particularly as it relates to everything surrounding the virus due to the health risks from which no one can be insulated without taking disciplined precautions.

The theory of the six degrees of separation suggests that each of us know someone who has been infected with Covid-19. Watching our loved ones, friends, or acquaintances suffer infects the rest of us with high levels of concern (emotion).

The broad based economic and financial impact resulting from the mandated lock downs left 40m+ people unemployed in the U.S. and killed hundreds, if not thousands, of small businesses across the country. The magnitude of the of this devastation arguably cuts the degrees of separation theory in half, or more. As the circle of influence tightens, emotions are compounded.

This environment only intensifies the more "normal" emotional influences that market participants must battle on a daily basis. The heightened volatility and daily swings in the equity and rates markets tend to increase the emotional tendencies, diminishing the staying power of those on the wrong side of the market and often forcing them to take action (book a loss or hedge in the hole) at the most inopportune times - times when the market is just about to turn back in their direction.

Take Emotion out of the Equation

How, you might ask? By learning the discipline of technical analysis of the markets. Through the study of price action, supply and demand, and chart patterns in a particular sector, one can formulate a disciplined, rules-based trading model that will do just that, take the emotion out of the process.

Unfortunately, this is not something that can be picked up quickly. It requires years of being a student of the markets before you can trust the signals that the market is sending. Identifying key levels in the markets and acting on those signals requires trust in yourself and in the rules that you have determined work best for you. In short, it requires expertise.

A discussion of some of the methodologies of technical analysis will be left for another edition on my Indicators and Insights Newsletter. The purpose of this article is to let you know there is a more expedient path to developing the discipline that will protect you from your emotions and improve your performance.

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I'll get to the point. Align yourself with a trusted partner who is independent and unbiased and whose expertise is in technical analysis of the markets. Someone who is not axed in the market can see more clearly than those who have capital at risk.

When you follow along with the daily analysis, monitoring the technicals becomes second nature, and you grow in trust. The best part is that this partner does all the work and presents it to you daily. You will know what to expect ahead of time and can take appropriate action at key levels of inflection in the markets. Here's how that works:

On Thursday (yesterday), the Bureau of Labor Statistics released the June employment report at 8:30 am. In advance of the report, the expectation was for a strong number with the consensus estimate for the number of non-farm jobs added to the payrolls at +3.0m.

In my daily morning report (sent at 6:45 am ET), I shared this perspective on the technical set-up in the equity and bond markets.

"The price action has improved this week, so much so that the S&P 500 was able to overtake the trend line (blue) and all three of the key moving averages. Not only this, but the SPX also found support last Friday and again on Monday morning in the vicinity of the 200dma (3022 this am). The index has since bounced to close at 3115 yesterday." (Note: 200dma = 200 day moving average)

This daily chart (high, low, close) on the S&P 500 went out with the morning report.

I went on to say: "The set-up on the S&P 500 is positive with key support below the market now and the index closing higher every day this week." "With the equity futures pointing to a +175pt gain on the DOW and to a +14pt open on the SPX, the stock market is geared up for a strong number."

For the bond market, this was my early morning insight:

"I'd expect to see yields follow along to the upside although support (yield resistance) at the 30dmas may not give way too easily."

"From purely a technical perspective, the set-up at the back-end of the curve continues to point to lower yields. The MAs remain in a positive cross (5dma below 10dma below 30dma). Yields have moved above the 5dma and 10dma although they remain below the 30dma. Yields have also been holding in a pattern of lower highs and lower lows. There is still trend line support (yield resistance) above."

"All of these factors, lined up together, require me to continue to encourage better buying on moves to the 30dma and to the trend lines"

The chart on the 30yr yield that accompanied this early morning commentary illustrates what I expressed:

Heading into the 8:30 am data, I expected to see a rally in the stock market and for yields to trade up to the 30dma in the initial reaction to the jobs number. Subscribers were able to anticipate this reaction and prepare to buy "on moves to the 30dma and to the trend lines." on the 30yr yield.

Not only that, I also gave them this insight and told them what to expect after the initial reaction to the data:

"The other thing to keep in mind is that the reopening of the U.S. economy is losing momentum. For that reason, an initial positive reaction (stocks, yields higher) is likely to be faded into a long weekend where the virus data will continue to show signs of spreading." (Note: "faded" refers to a reversal of the move)

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What actually happened?

+4.8m jobs were added in the month of June, well north of the +3.0m expected. The recovery in the labor sector is happening sooner than most had expected.

The S&P 500 jumped as much as +50pts (+1.60%) to 3165 . . .

. . . and the 30yr yield spiked up +4.8bps to the 30dma at 1.417%.

Then what happened? The initial moves on the S&P 500 . . .

. . . and on the 30yr yield were "faded" (ie. reversed), as expected.

Specific to the 30yr, those who bought the move against the 30 day moving average at 1.471% and sold it into the close in the 1.427% area would have booked a profit of $10,638.00 per 1mm bonds at risk (5mm = $53,190.00, 10mm - $106,380.00). In dollar terms, $1-02pts.

Following a disciplined, rules-based trading model sets you up to react to what the market gives you. This is the thought process: If this happens and the market moves to this level, then I need to take this action. This approach helps to protect you from your emotion.

When you have a reliable partner who provides valuable insights, helps to put things into perspective, and lays out these key trade-able levels, you'll grow in confidence and enhance your performance in the markets.

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This article is part of my LinkedIn Newsletter Series: Indicators and Insights – Perspectives on the Top Financial Market Movers with a View of What's to Come.

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This report represents the opinions of its author. It reflects market and financial information that we have obtained from third party sources; we believe it to be accurate, but we make no warranty to that effect and are not responsible for any inaccuracies in the information presented. Nothing in this report constitutes personalized investment advice to any reader or a solicitation to effect or attempt to effect transactions in securities. All investments involve risk. Past performance may not be indicative of future results. Due to various factors, including changing market conditions, the opinions set forth in this report may no longer reflect the current views of the author. The author is not an investment adviser, law firm, or accountant, and nothing in this report should be construed as investment, legal or accounting advice. Additional information is available upon request. Copyright (c) 2020. All Rights Reserved. The Mitchell Market Report,LLC