What about the Canary?
Remember in the last episode, where we discussed the short squeeze I was waiting for, along with three potential, macro, bullish catalysts? Those three catalysts being: 1) a resolution of the trade war with China without further escalation, 2) threats against Mexico not coming to fruition, and 3) a rate cut by the Fed.
Well, as I began my segment at the NYSE on Cheddar right at market open last Tuesday, the short squeeze really came into play.
So let me take the time to explain what a short squeeze is, why it’s so important, and something I like to call ‘a canary’ (plus, what you can trade with this)…
What is the short squeeze, and why is it important?
A short squeeze occurs when sentiment gets very bearish, and traders are loading up on puts. When everyone’s short, and there’s no one left to short further (to continue pushing prices down), AND there’s a positive catalyst (like the three I mentioned above), what does the market do? The market will gap up overnight. This causes shorts to panic… and squeeze them.
What do I mean when I say they get squeezed?
Imagine yourself, looking at the market falling throughout all of May, and finally deciding to get short. Then, low and behold, President Trump comes to an agreement with Mexico, and the macro situation doesn’t look quite so bad. You wake up to a market gap up, and your short positions are deep in the red. What do you do? Panic, most likely, and buy back your shorts.
Well, if that happened to you, you’re not alone.
Because that’s what caused the S&P to rally over 130 points last week. Not only were shorts buying back their positions, but bulls came back out of the shadows on the confirmation. These actions sent prices skyrocketing higher.
This is exactly why I talk to you about the put/call ratio and working to identify WHEN the short squeeze will happen. You 1) don’t want to be caught short, and 2) want to trade the skyrocketing momentum higher.
Now, as of June 11th, the short squeeze is running out of momentum, and it’s now time to start trading (on a very short term basis) to the downside
How do I do this?
Well, we discuss Phoenix all the time… but in this instance, when a bullish rally is fading, I look for the canaries.
What’s a canary?
It’s the canary in the coal mine, of course. You watch for the signal that weak stocks are dropping off. This tells you they’re falling first, and you can then make money by shorting them. If you want to trade the market both ways, you have to recognize the strong stocks on the way up… and the weak ones on the way down.
So who are these canaries then?
For me, the canaries right now are the industrial, financial, and transportation sectors. These gave us the first hint. And, you have to remember, that all industrials are not created equal. Companies like Boeing, John Deere, and Caterpillar have been hurt the worst by price action over the course of the last 6 months, but the defense industry is incredibly hot. Why? China! And tariffs!
Going forward, I’m going to trade the downside of the market on a short-term basis, and then, when the market starts to turn higher… can anyone guess? I’ll look for Phoenix.