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Risk-ON cycle breakdown from smallcap perspective and GME stock


The month of May started with a bang. Unnoticeable to many cryptos or smallcap traders, big market cap markets ignited early into May. The usual initiation suspect: the bond market. 


In nature, the rule of hierarchy can be seen everywhere, which is well respected, and the same is true for markets. Traders should pay attention to what is happening outside their interest market niche, as that will help us see where the flows should trickle to next. Measuring risk ON/OFF score can also better prepare us ahead on what asset we should focus on and which assets should outperform / underperform

Does it make sense to trade primarily large-cap stocks when risk-ON is near maximum? Not really. It is more likely that small and exotic instruments will provide a more interesting and rewarding environment.

Should we focus on trading small-caps when risk-ON is soft, or perhaps the market is in risk-OFF? Not really, because smallcap markets will most likely underperform large caps and be more likely in colder action environments. Better action elsewhere, currency markets for example.


But it's not just that. We can decide when to switch assets based on how deep into the cycle we are. For example in the early stages of risk-ON (just when it rotates from risk-OFF) typically large-cap assets start to squeeze first. It makes sense to focus earlier on larger cap names and then gradually shift attention once smaller market cap names start to prove themselves. Especially if one is trading long.

But enough about selecting the right asset classes, let's dig into Mays's risk-ON cycle.



Start with the biggest asset class first

(credit - -bonds)



Always start with the biggest asset classes first to find initiations (such as credit/bond markets). Markets have a hierarchy of flows attached.


-To find answers for small-caps typically you have to seek within a large cap stock market.

-To find answers for large-cap stocks you need to look for answers in bond markets and the dollar.

-To find answers within bond markets and dollars, you need to look at global events, such as central banks, geopolitics, and basically the chessboard actions of elites.


It is no surprise that bonds (TLTs or 10y US treasuries) were once again a key chart to follow. In November, the rotation in bonds from a prolonged multi-month downtrend to a bottoming rectangle and then inversion on 1st November 2023 was by far the most important chart you could track at the time.

The exact same situation was repeated on May 1st, giving us the same insight. This is why my highlight under bonds section of the discussion i had with traders was as follows:



Clean overlap with November, which led to replication. November's risk-ON cycle was very strong, and so was this one in May. Bonds played a key early role, providing us a heads-up before the momentum started to ignite. Keep in mind, that bonds rotated trend May 1st, and strength in risk-ON began several days later in stocks and crypto. A well-valid early signal.



The key catalysts that triggered risk-ON in May



It's important to keep in mind that the global market risk profile switch from risk-OFF to risk-ON doesn't happen just randomly. Like some smallcap stock starting to squeeze at random hours of a day. Coordinated action of global institutional flows only happens if there is some meaningful supporting catalyst. Something big.

For example, SPY/SP500 can turn without a major catalyst while most of the other risk profile instruments are idle. Sometimes that happens, SPY starts to sell off but the dollar is flat, bonds are flat and nothing else is moving too much.

But all risk profile instruments (dollars, bonds, stocks) won't turn all at once unless there is a major catalyst presence. Always make sure to double-check whats moving the market. Sometimes you will have to call markets bluff.


Let's step back first to provide context before the May. March and April 2024 and the risk-OFF presence was established due to geopolitical events (largely):




As you are probably aware, the entire duration of April was full of geopolitical escalatory news from the Middle East, especially the most sensitive ones between Iran and Israel. While Israel has been engaged in this situation for more than half a year, what really pushed markets over the edge was Iran being brought to attention last March. It is no coincidence that this is also where risk-OFF began. Equities started plunging hard.


After three to five weeks, gradually market got used to developing stories between Iran and Israel and as soon as the exchange was finished and both countries took a step back (as in all prior exchanges over 4 decades so far), the selloff in the market cools down towards late April. But that is not what actually created reversal into risk-ON.


Reversal came from central banking policy updates, FED and BOJ specifically around May 1st, leading to recovery in bond prices, creating the base for the risk-ON rally. To have a strong risk-ON rally, the base needs to align first, which is the bond market and the dollar. Bonds up, dollars down and you have a strong base.


Two key central banking events both took place around 1st May, which was key that triggered risk-OFF to shift into risk-ON:


The first news article above relates to the Bank of Japan's intervention in the currency market, propping up the falling yen. This had major implications for bonds and forex markets, and the second FOMCs meeting which also delivered a risk-ON response, just as the Bank of Japan did. Combo catalyst, both delivering the same reaction, doubling up the flows. 


As a context yen was falling for weeks and it started to worry global markets, intervention of Bank of Japan has led to yens recovery, and had impact on broad market stability. Since yen is one of the most important global currencies besides the dollar, it shouldnt be a surprise:




As we can see from above chart, interventions in yen were in end of April and May 1st.

And from the US central banks perspective and above mentioned catalyst, FED did not mention back in early May about any plans for rate hikes this year, even that inflation has been somewhat heating up lately. That created relief response for markets. I didnt think at the time it will, but it did.


We should also mention that around the end of April is when we lost geopolitical bearish catalysts in the Middle East, as Israel and Iran were saber rattling for an entire month, and then finally cooled down exchanges by the end of April. This opened a relief rally for markets.

We had basically all three major global catalysts going for the risk-ON side. BOJ+FED+Mid-East. And that's how the biggest risk-ON explosions always begin, it's not just about the US, or about the EU. It's when globally conditions improve at once. 3 big continents all at once firing with risk-ON catalysts.




Typically once bonds recover and the dollar starts to weaken, the market will start to bid up equity indexes (SPY) and large-cap stocks. If conditions ease a lot IWM (Russell 2000) index might also get a bid, which widens the risk-ON room for speculative tail-end assets. And that's exactly what we get at the start of May.


Remember that not every risk-ON cycle is the same, and not all are very strong. Sometimes SPY can be strong and bonds can be in a soft uptrend, while total risk-ON is softer, which might not lead to the strengthening of IWM. Without strong IWM and Bitcoin the tail of risk-ON doesn't open up, which prevents altcoins in crypto and smallcap stocks from increasing in activity. 


This is why from a personal angle, I always make sure to deploy bullish bias and expectations for major runners in smallcaps when risk-ON is opened near max, for which we need to see IWM strong and Bitcoin strong. Those two assets/indexes are typically good signs for excess liquidity in highly volatile speculative assets. This typically leads to action in small-caps sooner rather than later, and mid-cap stocks as well.


Due to how much IWM has strengthened in early May my bias was straight away bullish for GME stock since early May as one of the go to assets. Keep in mind, this was way before any Roaring Kitty and WSB drama got the spotlight on the stock. By using a risk profile one can already anticipate which assets market makers will bid up. When risk-ON is at max score, short squeezes will happen in many assets. And no this isnt pump groups and fellow Robin Hood leaders taking charge in short squeeze, its institutional flows that do the lifting, thats why one can recognize it ahead in first place. Some highlights in advance from personal X posts:



GME around 10-12th May was, in fact, confirmation that mid-cap stocks are gaining traction and a major increase in action, which was key confirmation that small-caps should start to move as well (at the time small-caps were still sleepy).


Think of it as green light trickle-down effect:


1.Bonds green light (May 1st),

2. Dollar green light (May 2 nd),

3. SPY green light (May 3 rd),

4. IWM green light (May 4th),

5. Mid-cap stocks green light (May 10th),

6. Smallcaps next?


So the only one left is then small-caps, which should get green-lighted as well since everything else is. And smallcaps are the tail more or less.

This is why when trading major risk profile shifts one could/should to trade different market cap assets to extract as much as possible from the entire cycle. In other words, if all you trade is smallcapped stocks you are leaving 70% of juice on the table because smallcaps start to move late into cycle ignition. Often similar for crypto and altcoins especially. If you spread out toward larger cap names, that is where the action happens earlier, especially in safer risk assets (NVDA, MSFT, EUR, or GBP currencies,...).



Let's draw more similarities between the Novembers risk-ON cycle and this one from the perspective of GME:


Let's overlap the chart of bonds and the IWM index, to highlight just how much the squeeze in GME had to do with risk-ON score strength. When bonds break a downtrend and rotate long-lasting down trend (each time in November and early May) this creates tons of bullish momentum and opens the floodgates, and IWM is the confirmation of that. GME is what follows:


Notice as well that each time when bonds and IWM stopped to rally and flattened out GME also stopped to squeeze. Happened both in December and May (several days ago since the post). This shows that nothing is really random. Liquidity pipes open, liquidity pipes closing.


GME as high liquid vehicle with tons of options activity and is very sensitive to risk-ON momentum in markets. This is the default, it has been true ever since 2020. If we are aware of that, as a default dynamic, we can start to anticipate that the asset should perform well when risk-ON begins. Can we anticipate a huge 500% squeeze like the one we had recently? Not really, but what is common is that 100+% does result in pretty much all prior risk-ON cycle cases. Sometimes it just goes more than 100%. 


If you have checked my prior articles on risk profile (which you should before reading this one, just use keyword "risk profile" as search) you know what cycles markets were in since early 2023. We can overlap GME price action into risk-ON and OFF cycles and we can notice straight away that every time risk-ON shows up GME does well, and vice versa in risk-OFF:



This is why my attention went to GME straight away on May 5th when IWM strengthened enough. That attention had nothing to do with WSB, Roaring Kitty, or whoever, it's purely in risk-ON strength response.


In fact, I think its fair to go one step further. In my view, both Bitcoin and GME serve a similar purpose. They are high liquid speculative short-squeezing names. Because of that, they are targets for liquidity raiding, but such raiding typically only happens when the market is in ideal risk-ON (where both tickers squeeze big). Therefore...this makes both of those vehicles in combination a CONFIRMATION that risk-ON is very strong. This then aided my thesis that we will see smallcap stocks ignite after GME squeezed up big, even that my expectations for heated smallcaps were already set earlier into month of May. Did this exact combo squeeze behavior happen in 2020 as well between GME and Bitcoin, which led to plenty of SC activity? Yes:

So keep in mind, GME+BTC strong squeeze behavior=risk-ON max. Be careful in small-caps as bear whenever risk-ON is near peak strength, or enlarge that buy button if you are long.



How important is it to track risk profile and risk ON/OFF for trading of small-caps?



Well, let's see. The months of April and May are great back-to-back comparisons because in April markets were in risk-OFF clearly. And in May it was the complete opposite, with risk-ON presence. What we can do is pull some quick data from small-caps, and notice differences in many behavioral categories. But before that let's highlight risk-OFF April and risk-ON May:

Those Tradingview images can be a bit tricky to read when so many assets are overlapped but I think that is the best way to go, to have it all on one chart.

Personal day to day commentary on cycle changes for smallcaps, and why around May 8-10th i had to re-affirm that we still should see ignition of momentum in smallcaps. Some traders have been asking if we are going back to weak flows in smallcaps, because 1 day before GME started to move the smallcap stocks were getting weaker day by day. My reply was straight away no, and that due to broad risk-ON cycle we should see some major squeezes still in SCs. As comment also highlights. Two days later momentum uptick began.

This is important to highlight because many times traders try to figure out where their market is going next by observing whats happening within their own market. And that's not how cycle projections really work.

To project where your market niche of focus should go, you need to look at what bigger market cap assets are doing, and whether broad market conditions are improving or worsening. Only this way you can project forward a week or more ahead for your X market. 

This is why some smallcap traders assumed the flows in SCs were done on May 8th, because of how so many tickers were fading that week, but broad markets were clearly giving a red light alarm for something to likely heat up big time. And so FFIE enters the chat soon later. Very similar thing happened in February risk-ON (Bitcoin squeeze) / HOLO and Chinese 1000% frenzy market. If you only paid attention to smallcap market, you couldnt havent seen the ignition warning.



Lets compare Aprils risk-OFF and Mays risk-ON market in smallcaps:


Noticeable significant behavior and data clusters in:


-Amount of MDR tickers: More MDR tickers in the month of May than in April.

-Amount/range of black swan squeezers: Ranges in black swan were much higher in May. 

-Elevated ranges on mid-day pumps: Ranges expand from the typical 70-100% move on the intraday pump in April to above 100% (around 150 ish) in month May.



The chart above has most tickers from April and May merged on single-screen overlaps. Even though it seems like a complete mess, notice that if we focus on a few variables they clearly highlight stronger performances in May from multiple directions:


-Average VPOC demand levels are higher in May. Tickers have more sustained momentum, and higher squeeze prices, and there are more of them doing that vs the month of April. This will impact short sellers as it creates more annoying behavior to short often.

This meaningfully impacts anyone no matter whether you trade long or short, but especially the bears.


-Black swan squeezes maximums expand significantly. One will very rarely see a 5000% squeezer in the risk-OFF market, but you will see 1000+% squeezers in the risk-ON market, and over the past year, that has in fact been standard. This is obviously by far the most important behavioral difference for short sellers, as those tickers tend to hurt those traders the most. This in my view one of the most useful components of why bears in smallcaps need to track risk profile changes of broad markets to anticipate black swans ahead. We noticed the same in February risk-ON of Chinese markets and HOLO being similar mover, and back in November/December with the same example.


-Several multiday-runin' tickers are stretched from April into May because the risk-ON market switch on May 1st allows those MDRs to still be sustained (it's rare in the risk-OFF market for a multiday runner to hold for more than 3 weeks).


What the above image does not highlight, however, which I find very useful is the first 30-minute behavior differences of risk-ON/OFF cycles for smallcap tickers, especially low-volume tickers with low % gaps (will leave this for next articles).

Those tickers tend to remain very cold in risk-OFF cycles if the ticker opens in a "cold state". Meanwhile, those tend to ignite "out of nowhere" often in risk-ON cycles. In my view, they make often great longs (low risk, good upside potential).


Example of early low volume squeezers in strong risk-ON cycle (personally have traded FLJ), this was peak risk-ON score day:


From personal observations one of the most common noticeable behavior shifts is that in risk-ON tickers tend to deliver often good early push even if they fade later on, making it worthy to attempt longs more than usual. And while most traders would assume that this applies to higher % gappers that trade on very high volumes, I don't actually mean that at all. Actually the opposite is it applies to low % gapping drier volume tickers.


A strong risk-OFF market will typically decrease ranges on small-caps, it will open up deeper fades, and prevent high % rallies. 

A strong risk-ON market will typically do the inverse of everything above.

The key with small-caps cycles is always to ANTICIPATE. Meaning, that one needs to be close to risk profile changes, and note when the market has shifted to be ready a few days in advance, because otherwise if one "waits for smallcap market to confirm the change in strength" it might be already too late as momentum can explode within a day or two fast. It is always more useful to anticipate ahead. Once the risk-ON score becomes near max, expect smallcaps to start heating up.


What would be near max risk-ON?

-Strong squeeze in bonds

-Bond yields plunging hard

-Dollar sinking consistently for days

-SPY very strong

-IWM with impulsive uptrend movements

-Bitcoin in a firm uptrend


On image below near max risk-ON in the recent cycle:

So to break it down chronologically once more, highlights:


Part 1:

-The April market is in risk-OFF, safer shorting environment, small-caps don't have much of surprise squeezers


-Early May leads to intervention in yen within Japanese markets and FOMC (FED) combo delivery from central banks leading to a surge in bonds and bottoming


-Strength in the yen (due to CB intervention) weakens the dollar, and risk-ON reaction to FOMC leads to more dollar weakness and strength in bonds, this now opens the path for upside on equities, SPY, primarily


-We can see that this opening wasn't just a 7 from 1-10 score, but higher, because IWM surged higher very soon after SPY responded. Showing that mid-cap stock flows are opening up as well, fast.


-Bitcoin rallies soon after.

All of above by the May 5th suggests we are opening strong risk-ON, and some big squeezes might begin soon in mid-cap or smallcap stocks.


Part 2:

-GME squeeze begins (midcaps)


-FFIE squeeze begins (small caps)


-We get black swan squeezes combined with elevated momentum across many tickers


All the above highlights on a single chart:


If you take a look at the overlap chart above its clearly noticeable that May 1st to May 3rd is where clear rotation happened in most assets all at once. That's what a typical risk-ON rotation looks like. It's noticeable everywhere where liquidity is (in assets that are liquid at all times).


This brings us to another point, to recognize risk profile changes we should never check the health of flows in low liquid assets, but always in most liquid ones.

The higher the liquidity, the more sensitive the asset will be to risk profile changes. That's because more institutional capital sits in those assets and such capital if crowded has a difficult time exiting when liquidity dries out, so everyone wants to rush out of the gates at once before the red light starts to flash. By the time the red light is on, the liquidity is already much weaker and assets deflated, making it even harder to sell large amounts of inventory.



Conclusion - hierarchy



If we break down the cycle chronologically everything makes sense, and nothing that happens in markets is really random including FFIE and GME squeeze. It is all about chain reaction, hierarchically from:


-biggest

-to large

-to medium

-to smallest


In market cap and asset risk quality. Each asset class has a certain delay effect as well, from 1 to a few days, after the biggest one responds.


Should smallcap traders keep an eye on broad markets and apply risk profiles on a daily basis? 


The behavior differences are noticeable enough that the answer should be yes in my view, and keep in mind we haven't even covered intraday behavior differences between April and May which would tell an even clearer story within smallcap stocks, in terms of:

-manipulation patterns,

-differences in failure of price once it swipes HOD between each month,

-the number of times fake breakouts reclaim,

-and other micro but very important behavior clues.

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