Late Stage Tactics

What’s goin’ on?

Sometimes I just want to wash my hands of the whole thing.

Understanding Market Trends and Institutional Strategies

There are three types of trends: up, down, and sideways. It’s far easier to make money in either an up or down trend. This primarily boils down to being on the same side of the trade as the financial institutions. To do so, we must recognize where the asset we’re looking to trade is in its cycle. Once identified, we need to manage our own expectations regarding shorter-term price behavior.

Over the last couple of months, we discussed opportunities that arise during trend changes. Institutions aim to move prices up as cost-effectively as possible while still accumulating their positions. To achieve this, negative storylines are often promoted, causing the average investor to become confused and fearful of potential outcomes. We’ll cover this aspect of Wall Street tactics in greater detail later. For now, let’s focus on why they do this and why it’s important.

Understanding the Business Cycle and Institutional Strategies

This business cycle graphic is included every month for good reason. It’s commonly accepted that ‘retail always buys the top and sells the bottom.’ Wall Street banks on it. Literally. Institutions rely on the retail investment community to provide liquidity (willing buyers or sellers) for them to dump their positions or acquire them. It’s always been this way and, most likely, always will be.

Institutions count on retail investors to buy what they’re selling and sell what they’re interested in buying. Until they’re ready to sell, they’re motivated to keep everyone out of the trade. This is why you may have heard the popular saying ‘the market loves to climb a wall of worry.’ As negative storylines are promoted in the media and by analysts, professional money begins moving their holdings higher. By the time the storyline changes, many of the desirable assets that will be positively affected by the change in sentiment are already at the levels where Wall Street is ready to take their initial profits. Retail investors begin to notice that this particular stock has been on a nice run, and now that their concerns have been alleviated by positive headlines, they’re ready to put a toe in the water. Once the fuse is lit, institutions can provide minimal support to the upward price trend, which is why you see volume so much lower during an actual uptrend. This is a markup campaign.

The same philosophy holds true at the top of the cycle when larger holders are looking to dump their positions on retail investors. News stories will become very positive, analysts will issue upgrades, reactions to earnings will seem favorable, and large surges of volume will come streaming in. It’s important to make your customers feel good about what they’re buying. What the average investor doesn’t realize is that the volume is so high because the professionals are leaving the trade. Retail always buys the top.

Understanding Volume Profiles and Market Dynamics

This is what it looks like. The volume profile (white bars extending horizontally from the left) indicates the shares that traded hands at various price levels. Notice the big volume spikes (bottom of the chart) as the price moves sideways at the top. Oppenheimer upgraded FSLY to ‘Outperform’ in January 2021. Raymond James did the same in February, and Piper Sandler put out an upgrade in March. The chart speaks for itself. More on FSLY later.

This is why it is critical to understand the business cycle and higher time frame charts. One look at this all-time weekly FSLY chart above should tell you what you need to know. It went from a low of $10.63 to a high of $136.50 in 8 months. That’s 1284%. Would you consider taking profits at that level? I know I would. The only way to consistently and effectively make money in the markets is to get off social media, tune out the financial news, and begin studying the data. Clearly, the information provided when Wall Street is ready to exit can’t be relied on. The same holds true at the bottom when they’re looking to buy.

Now, imagine if you had taken a position at the bottom in Q1 2020 and had recognized the volume surging in a sideways trend from mid-2020 to early 2021. This would have been a clue to take profits and possibly consider taking the other side of the trade. Meaning, it could be time to go short as Wall Street is clearly unloading their positions. They’ll want to reload their inventories much lower, so why not join them? Buy when they buy. Sell when they sell. This is how multi-cycle profits are made. “Be fearful when others are greedy.” -Warren Buffett

How is that affecting things?

I can’t just walk away but it’s so hard to figure out how to handle the situation. There’s so many mixed signals!

This brings us back to monetary policy and how it adds a layer of complexity. Last month, we discussed how monetary policy affects the value of the $USD and the impacts of a rising dollar on emerging markets.

Disclosure: No current position in EEM.

We also discussed how financial institutions have been taking advantage of this by building very large positions in this sector. As negative headlines continued, Wall Street was buying at a pace not seen since pre-Covid. Oddly, that was the last time this sector went on a huge run.

Wall Street vs. Financial Media: Understanding the Disconnect

It shouldn’t be too surprising that Wall Street often does the opposite of what the financial media suggests retail investors do. Right? Isn’t that what always seems to happen? Think about all the headlines we’ve seen since COVID and how scary the investment environment has been. We’ve been hanging on every word from the Federal Reserve for almost three years now. Why? Because we’re told that’s what’s wrong with the market. Rising interest rates have caused the markets to fall just as fast as they rose during the COVID bull market. Right?

Well, it has really only impacted certain sectors of the market. The S&P 500 has actually done great after the initial plunge. In fact, the S&P 500 has historically performed well during rising interest rate environments.

It’s the interest rate sensitive sectors of the market that have been really beaten down. It’s in these sectors where the expected changes in monetary policy should have the biggest impact and where we would expect to see institutional activity as they prepare for the recovery as financial conditions ease with lowering interest rates. Or, if there still remains concern over inflation and the potential for additional rate hikes, we should see that reflected in high dividend paying sectors like utilities and communications. They have historically underperformed during rate hiking environments.

Disclosure: No current position in XLU or any companies within the fund

This is the weekly chart for XLU, the ETF that tracks the Utility sector. If there were concerns about additional rate hikes, we would see them here. Not only do we not see any concern, utilities are breaking out. Why? Well, utilities typically do very well in recessionary periods. But, we’re not in a recession. The real reason why they’re breaking out is the institutional buying that took place at the bottom. Not the impending recession that we’ve been hearing about for over two years now.

Disclosure: No current position in XLC or companies within the fund.

XLC Weekly Chart and Interest Rate Concerns

Here’s the weekly chart for XLC, the ETF that tracks the Communications sector. Not surprisingly, any concerns about rising interest rates have long since faded. This sector is now testing all-time highs, though volume has significantly dropped in May.

So why all the concern about interest rates and the possibility of additional rate hikes? Because it makes for great headlines and induces emotional responses from the retail investment community. Remember, the media (including social media) is part of the resources available to Wall Street, and during trend-changing periods, they exhaust all of their resources. There are literally billions of dollars on the line.

As we mentioned last month, this was the perfect setup for professionals to use backtesting tactics and dramatic price swings to acquire more shares. How many companies did we see post solid numbers, beating both earnings and revenues, only to see their stock prices plummet? Let’s take a closer look at a few examples as we discuss late-stage institutional tactics and the current Supply vs. Demand condition.

What can we work with?

Things were moving right along and our plan seemed to be working. Then suddenly the rug got pulled and we ended up right where I started. Now I’m questioning everything! 

Navigating Market Volatility

It’s important to note that many of the trend change opportunities we’ve discussed are still being accumulated by financial institutions. Although we’re seeing demand > supply conditions becoming more common, there will be periods where sudden surges in supply occur, often before or after regular market hours. These highly volatile periods typically don’t last long and correct relatively quickly.

This strategy is used to acquire more shares by taking out the later entrants into the trade. As prices have been moving up over the previous few months or weeks, retail traders are attracted to the returns that have been produced. They’re likely to take profits as prices continue to move up and, because most have recently entered, have stop losses that are relatively close. Many traders enter before earnings, expecting a positive response to what they believe will be good numbers. As larger interests are ready to move price out of the accumulation range and to higher levels, they don’t want these new entrants selling into them, forcing them to acquire those shares. That raises their costs. From their perspective, it’s better to take them out of the trade now and continue to build their position for the upcoming bull run.

These surges in supply force prices to rapidly drop, as retail investors aren’t capable of producing an equivalent level of demand. Volatility is the result, and what appeared to be an upcoming breakout turns against the retail investors as price falls, often overnight. It’s critical to understand what is happening in the larger scheme of things. Although prices may fall on a good earnings report, and recent lows may be tested, the overall position in the larger cycle hasn’t changed. Those in the trade for the medium (3-6 months) or long (2-3 years) term should consider adding to their positions during these periods.

Case Study: Shopify (SHOP):

Shopify went through an accumulation period during 2022. It then went on an almost 400% run, setting a series of Signs of Strength as it broke out of the range. They posted solid numbers on May 8, beating earnings expectations by almost 18%. The next day, the stock opened down almost 19% and may be setting up for another leg lower. There’s a gap in the chart from Nov 2, 2023, when it gapped up 22% on another earnings beat. This is a prime example of institutions reaching their first profit-taking target (.618 Fib is $81.81) while retail investors are still coming into the trade attracted to the recent returns. This pullback is the first corrective wave (wave 2) of the impulsive wave structure. As previously discussed, this is the institution’s effort to push out the ‘chasers’ who would likely sell into them as they continue their markup campaign. After completing this corrective wave, wave 3 should follow, which is typically the strongest. By taking out the retail investors now, the larger operators clear the path of resistance for the next move. Retail investors will once again be attracted to the rapid movement in price when Wall Street is ready for their next profit-taking level, likely at the 1.618 Fibonacci level.

This is a great example of how short-term supply > demand conditions are used by Wall Street institutions to accomplish their goals. They want potential short-term profit takers out, so they take profit, dump supply onto the market, and force prices down until buyers step in. Once there, demand > supply conditions will be re-established to continue the uptrend. This is how the market works. Those in the trade should have been watching the .618 Fibonacci level and either taken profits there or, at least, raised stops to the 30-week simple moving average.

This is the second negative reaction to a ‘double beat’ earnings report in a row. Tracking the institutional business cycle and aligning your trading plan accordingly is the only way to avoid these types of situations.

We don’t often use daily charts as they’re too susceptible to shakeouts and very short-term volatility. Using them here to capture the earnings data.

Disclosure: No current position in SHOP.

Bullish scenario: Demand comes in to defend the gap and price recovers the now downward sloping moving averages. The corrective pullback is complete and the next leg of the uptrend begins with wave 3. 

Bearish scenario: Short term supply > demand conditions continue taking price down to fill the gap at $48.79. 

Datadog (DDOG) and Late Accumulation Tactics

Datadog is in an almost identical position to Shopify. In fact, we could probably list about 15-20 stocks that are in the same situation. Perhaps you’ve noticed all the negative earnings reactions this earnings season attributed to more rate hikes or rising yields. Those following the business cycle covered extensively in this edition of From The Trading Couch know better. These are prime examples of late accumulation stage tactics used by financial institutions to improve their bottom line and advance their agenda.

DDOG has also seen two negative reactions to positive earnings numbers and is completing the first corrective wave of the new uptrend. Notice the very low volume in late May as the price approached the moving average cluster it had lost. Then, suddenly, large supply volume comes in, creating the temporary supply > demand condition, forcing the price further down.

Disclosure: No current position in DDOG.

Bullish scenario: Corrective wave 2 completes at this level after taking out the liquidity below the Jan ‘24 low. Demand returns and wave 3 begins. 

Bearish scenario: Sellers continue to bring supply in volume, shooting to fill the gap from the +28% earnings reaction in Nov ‘23. In this scenario, good chance the liquidity below the Oct ‘23 low will be taken out as well. 

Navigating Late Stage Tactics: Examples from DDOG, SHOP, and FSLY

Both of these examples mirror the FSLY example used earlier. These late-stage tactics can be very challenging for investors on the long side of the trade. Wave 2 is typically very harsh, as a large percentage, if not all, of the gains from wave 1 are erased. It’s in difficult times like these that members of From The Trading Couch and Clarity have a distinct advantage. When the vast majority of the retail trading community is panic selling, thinking the trend has reversed and new lows are coming, our members are either re-entering or adding to their positions. These are great opportunities for those who can recognize them and trade alongside Wall Street institutions. Others will find themselves shaking their heads once again.

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