Annus horribilis 2022
2022 has been a challenging year for both investors and traders.
2022 was the year when interest rates rose sharply in the Western world, after having gone to historically low levels. With the exception of cash and a very few raw materials, this has led to significant falls in the price of most financial assets. At the time of writing and with about a week left in the year, we can highlight a number of examples in the table below. The return figure is per closing 22/12/2022 set in USD for all asset, to make them comparable.
The table shows some interesting results. One is that "everything" has been weak. As an investor, it has been very difficult to find anything that has generally done well. There will always be some companies and narrow niches in the market that have done better than others, but the general picture is that it has been a very bad year for most financial assets. US strategists have stated that 2022 has been the worst year in terms of returns for a classic 60/40 stock/bond portfolio since the Great Depression of the 1930s. That says a bit. These are not normal market conditions.
The second point is that assets with an assumed long duration (income flow far into the future) have taken the biggest hit. Innovation stocks and cryptocurrency have seen 2/3 of their value disappear. Even the allegedly conservative Nordic property stocks have been halved.
Broad stock indices with a large element of industry, such as Germany's DAX 40, S&P 500 and Sweden's OMXS30 are down 20-26%. The strongest in the table is the oil- and shipping-heavy Oslo Børs Fund Index, but this is also down almost 17% measured in USD.
One can therefore safely say that it has been a bad year for investors. What about traders? It is not as easy to objectively obtain data, but we have some evidence. Most professional traders I have spoken to in both the US and Norway say it has been very difficult to make money from trading in 2022, and the results are stated to be slightly on the negative side. If we look at figures from HedgeNordic, which covers the Nordic hedge fund industry, we see that their broad NHX Composite index containing 142 funds was down 5.72% per the end of November. The narrower NHX Multi-Strategy index, which also includes the fund I manage, was down 7.14% per November. Internationally, too, we have seen large, well-known hedge funds with a long history struggle this year. For some of the most high-profile funds, it has been their worst year ever, and there are reports of falls in the order of 40-50%. You can safely say it has been a difficult year. The Latin expression "annus horribilis" fits well. 2022 was a bad year.
Trading in a bear market
Some may wonder why the year has not been better for traders. After all, we have the opportunity to go both long and short, and generally thrive when there are significant fluctuations in the market. This is a good question, and every trader must find the answer by studying their own trading history. Nevertheless, we see that the results are generally a bit on the negative side, although not as much as for the long-only funds. I think the explanation is somewhat hidden in how bear markets behave in general, and in addition there have been some special characteristics of this one.
Firstly, it is generally more difficult to trade in bear markets than bull- or sideways markets. It is not that the trend has reversed from up to down that makes it difficult, nor the level of fluctuations (volatility). Rather, the challenge consists in a lack of trending throughout the day and that many of the larger price movements come as leaps overnight, and then often as a reversal in relation to the tendency the day before.
A common type of setup for traders in normal market phases is this:
- Look for stocks that have shown strength relative to the market and have now consolidated for some time within an uptrend or just below a technical resistance level. Be particularly alert if these begin to move in smaller and smaller fluctuations just below the resistance level. You can almost feel the building of energy in the same way as a spring being stretched.
- Buy these when they break through the resistance level. If the first day is strong, increase the position towards the end of this, or on continued strength on the second day. Hold day 3, or if this is strong, start scaling out. Reduce days 4 and 5 either by scaling out and/or pulling the stops upwards. Possibly scales out when the stock is testing resistance levels on the upside if these exist.
These are good setups under normal market conditions, and very good in bull markets. As a trader, you also find these in bear markets like this year, and reflexively you trade them. Sometimes it works well, but this year a great many of these setups have failed. Instead of ready-steady-go, it has become ready-steady-stand or ready-steady-full reverse. And often the reversal happens overnight. Thus, after a strong day or two in the market, a trader may have taken on a number of positions for follow-up movement the next day. Then it's tiring when you turn on your computer in the morning and see index futures 2% down. Typically, all positions then go into stop-loss at opening, and if you have some high-beta shares and want to stop them out in thin morning liquidity, it will not be -2%, but -3 to 5%.
A trader's result over a year is summarized and determined by the hit percentage (winners in relation to losers), as well as how much one earns from the winners and lose from the losers. The goal for most people is to have a hit percentage well above 50%, lose little on the losers (tight stops) and, in sum, make more on the winners. In a market with many sudden reversals and jumps from day to day, a trader will often experience both that the hit percentage is slightly weakened, and that some of the losses are slightly larger than expected because the prices jump past your stop-loss level overnight. It does not take more than an increased occurrence of this for a trader to end up at zero or minus.
The other trend I have observed in the market in 2022 is an increasing occurrence of quick counter moves before larger price moves. For short-term traders, this is simply a "feint" where prices breach obvious stop-loss levels and abruptly reverse. There have always been some of these in the market, but my impression is that they have occurred more often this year. Possibly because several professional actors such as market makers and trading robots use technical/quantitative analysis. Below is an example that I review in some detail.
NASDAQ – 100 E-Mini Futures, weekly two year chart
NASDAQ – 100 E-Mini Futures, weekly five year chart
The chart above shows NASDAQ 100 futures with 10-minute candlesticks from December 20 to 22. We see that the prices were in a clearly defined trading range before the opening of regular trading on the 21. at 15:30. If we had looked at a slightly longer chart we would have seen that the NASDAQ had had a significant pull down in the previous days and it was not unreasonable to assume that the consolidation range would be broken on the upside for some correction of this larger down move. If one took a position in such a scenario before the US opening, it would have been common to have a stop-loss either at the bottom of the last candlestick in the middle of the range prior to opening, at the bottom of the trading range or at a breach of the level the futures reversed at around 1:00 p.m. earlier that day.
What the chart shows is that in the minutes after the US opening, the prices slumped below all these levels. This means that all stop-losses that were there were triggered, and the positions taken out of the market. In the following minutes, prices reversed strongly and broke out on the upside of the trading range. However, we see that buying this break-out was not easy either. Prices immediately fell back to the mid-range for the next few minutes before breaking to the upside again.
My point in showing this is to illustrate the practical challenges encountered in the market. When you find an attractive setup and take a position, you must have a stop somewhere. The example shows that the most obvious stop levels are often "gamed" or "wiped" in movements that are so significant that they can hardly be avoided. What about not having a stop when the range is broken on the downside? The year 2022 is full of examples that in that case you would have to take the stop 1-2% further down. Tight stops have not been ideal, but still better than the alternative.
The challenge of this can be compared to playing poker against experienced poker players. One must not only have a good hand and play it well, but also have the ability to recognize when the opponent is bluffing.
So what is the solution to this for traders? You can almost say that there is no ideal solution. If you have positions in the market ahead of such a movement, they will often be knocked out at stops. If you do not have positions, you can be well prepared to wait for just such a scenario as above. Then you can sometimes achieve using such stop-losses to enter positions instead of being knocked out of them. I myself carefully map such movements now in my archive and study them with the aim of profiting more from such setups going forward.
And with that I would like to wish all traders and readers of my articles a Merry Christmas and a happy and profitable 2023.
Disclaimer: After many years in the brokerage industry I started my own business in 2021. I published the book "Paleo Trading: How to trade like a Hunter-Gatherer” and launched Paleo Capital that manages a hedge fund according to the principles described in the book. I emphasize that nothing written on this blog is to be regarded as personal advice or a concrete call to take positions. Everyone must be responsible for their own decisions and familiarize themselves with the products they use.
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