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Risk profile analysis part 2


Risk profile analysis can be very beneficial for any trader or market participant. It is a cross-market analysis driven by the market cycles. Big asset classes drive smaller asset classes in their reaction (never the other way around), and therefore if one is trading or investing in smaller market cap assets (as many traders are) then paying attention to changes in risk profile flows is key. Tracking smallcap / exotic markets without paying attention to large asset classes will always leave impression of randomnes in moves, because one does not know from where does momentum originate.


When traders are typically bagged in positions it is typically when one is over-exposed with longs at the prolonged stage of the risk-ON cycle, which then turns. The flows shift from risk-ON to risk-OFF leaving you with trapped positions. And because the shifts between risk-ON/OFF often last quite some time (one month plus) it might be too late to recover those positions as typically asset prices can deflate a lot just within that single month of risk-OFF duration.


This is why paying attention closely every single day to changes in risk profile flows is a must. That is how one avoids getting bagged. No matter what asset class you select this will apply.


From a swing trading perspective, the worst thing a trader can do is to have significant long exposure and the trader ignores the risk profile information and the changes in cycles. If the cycle does change from risk-ON to risk-OFF (the signal for which will be visible in a single day of market session) it will create a big problem of likely trapped positions. Remember that when risk-OFF kicks in majority of equity or crypto instruments will decline! This means that the chances for one to have long exposure to that "lucky" instrument that will not decline is not high at all.





Diversification? Think again.



So that we start the article with a bang, let's highlight just how much above is true with examples of many different crypto alternative currencies (which are supposed to be very different in terms of asset structure of float, market caps, functionality, etc...) but none of those differences matter much.

When risk-off kicks in, most of the assets will tank. This is how we can highlight the impact of risk-profile flows regardless of assets' "high quality status".

The only differentiating factor typically is just how much in % terms any ticker will drop. Lower quality assets drop more and higher quality ones drop less, but overall most risk-seeking assets will decline, which is what matters for trading direction.


This is August 1st and the ignition of the risk-OFF cycle. Notice how pretty much all assets declined as risk-OFF flows kicked in global markets, regardless of "functionality diversification between tickers/companies". SPY declined, large cap stocks declined, crypto declined. By majority.


We can notice that even though one might consider a "diversified portfolio" of having some stocks and crypto, the reality is in a risk-OFF cycle most of those instruments will decline at once. This means that the correlation will increase close to 1:1.


The key message of the above lesson is to understand just how strong an impact the changes in global risk-profile flows are versus the self-analysis of the company one is trading or investing in. The fundamentals (shiny horses) are often not able to hold the bid on the ticker if risk-OFF kicks in.

Always prioritize risk-profile analysis above fundamental per-company or per-asset analysis. Cycle flows can hammer even quality assets if the changes are strong enough.

There is multiple ways to implement risk-profile analysis into trading and investing, but without the doubt swing trading benefits the most from it. Short term trading as well but there is a higher ratio of usefulness when it comes to swing positions.


Track cycle durations




This leaves us with the observation that keeping track of how long the cycles last is beneficial as well. Since each "clean period" of risk ON/OFF will only have a limited duration. Strong ignitons in either way last about 2 to 4 weeks perhaps, and the rest is a lot more choppy and neutral. This means that once either cycle lasts with intensity and proper strength for a while the chances are what follows next is the neutral period, or the inverse of flows. However the overall problem is unconsistency in exact durations. Some cycles last very long, and some are very short. One thing that however is common of them all is that high intensity has good overlap on the shortness of how long it lasts (2-4 weeks). That "intense" period is where best opportunites are. And that "intense" period is typically what bags many traders who are not paying to that, overstaying the cycle as likely result.


The later you are into the cycle the more that will apply. Therefore always be aware of WHEN each cycle began! The closer you are to day 1 (the actual ignition day) the better. The more likely it is, what's in front of you is major trend extraction, plenty of early opportunities (swings), and so forth. And the later you are, the inverse is true. The fewer the RRs, the more likely it is to get bagged in swings. So track those cycle transitions and mark them on the chart if you will.


This is the second piece of the article, and therefore we will not cover any further basics as some of that was outlined in the first article:

It is highly recommended to read the first article before going further into this one, otherwise, it might not make much sense.



The usefulness of Risk profile analysis in 2023 versus prior decade in 2010s



Especially 2023 and 2022 are by far the best years to highlight risk profile analysis. Lets break down what that is:


Over many years of the 2010s (until 2020) the broad cycle was relatively steady. Not much of a sharp flip-flopping between risk ON and OFF periods. This correlates to macro economic and geopolitical developments (relatively steady decade). We have seen the peak of globalization in the 2010 to 2020 decade and after the early start of the 2020s, we are heading into a more de-globalized world, or perhaps better term fractured geopolitical world, causing a lot more stress on global markets.


Because of that those are the exact right years to use risk profile analysis to our advantage in markets because there is A LOT of flip-flopping between the flows lately. What I mean is, that one month is strong upside momentum with risk-ON, and then before you know it new surprise negative catalyst hits and turns the flows completely into fear mode and risk OFF. That has been the story of the entire past 2 years, and I believe it will remain highly likely present for a minimum of the next 2, because of the broad cycle of geopolitics. In such an environment understanding risk ON/OFF transitions is necessary because markets are very choppy and go from strong uptrends to strong downtrends. SPY's chart pretty much summarizes this:



Remember that, a flip-floppish market is the hardest trading environment. It requires out-of-market participants to bring as much knowledge as possible to navigate those treacherous waters. To underestimate that is not a good idea. And that's where risk profile cycles come into play.


This flip-floppish ehavior is typical for higher inflationary periods in history when markets become very sensitive and there are a lot of fear/greed flow transitions that happen frequently because of it. That is why often some call those periods "stock picking periods" and no longer "zombie index investing" periods.

When inflation upticks quickly (due to geopolitics) the nature of markets becomes tougher. And some stocks will overperform and many will underperform, pushing market participants into "stock picking" mode much more. Otherwise, one can just buy an index and sit on 0 return for a year, which is no fun.

We can apply "stock picking" of inflation periods to any market by itself because the constant transitions of risk ON/OFF create necessary asset selectivity in any market that you touch.


From the risk profile perspective for ideal equity conditions, we need all key assets from the risk profile analysis to match in the right direction as much as possible.

If one key asset is non-aligned it can cause equities to struggle.

For example, 1.if bonds are stable, 2. yields are dropping, and 3. oil is stable, but the 4. dollar is in a stronger up trend- that is not an ideal equity environment. All should be aligned in the same direction, and we had a bunch of months in 2023 where dollar strength was preventing equities from escaping higher. This served as a damping mechanism on equity flows. Strength in USD showed a lack of risk exposure from market participants and a more cash-defensive stance.

This is why for ideal longs in equities we do want to see attention from dollar strength being taken away and buried from the news. And vice versa, if one is looking to short equities, the strong dollar will be aiding and preventing equities from escaping far up. Especially when we are not talking about just one intraday strong dollar move but a consistent trend over days or weeks.



Track large catalysts daily




Track catalysts because most of the time risk ON will shift to risk OFF on some strong catalyst release. The problem is that beginners and even many experienced market participants do not know what validates as a "key" catalyst to track on the day. Because on just any day it could be 5 high-impact news releases on the economic or market side.


Mostly it's central bank policies that cause shifts of those flows, or what central banks tell us is the key to look for (hint hint inflation and CPI prints). This means that overall institutions pay the closest attention to either CB meetings or policy updates, or they weigh the input of the news types that the central bank points them as key to worry about.


This is why we had over 2023 and 2022 large chunks of risk ON/OFF flow reshuffling happening on CPI news reports and general inflation comments from FED! FED and told us and markets repeatedly, this is THE story to worry about. Inflation. Markets become sensitive to that.


The above should provide you with some clarity on what you should prioritize as a market observer. It is mindblowing how many traders will track NFPs, manufacturing index reports, or housing market reports, but they won't spend too much time paying attention to central banks, let alone trying to "understand" their policies from a non-judgmental perspective. If you understand which players drive the markets, you'll understand why paying attention to central bank policies is the key.


To wrap it up: Because we have an inflationary era in front of us due to geopolitical changes one needs to pay attention to risk ON/OFF sentiment changes closely as constant new bearish developments globaly are introducing much more frequent risk-OFF cycles than in prior decade! Keep in mind, if that was not the case, and risk-OFF cycles were not frequent, the whole point and use case of that article would be 0. You don't need to worry about cycles when you have for an entire decade just more or less one type of cycle. The attention to cycles gets highlighted once you introduce a flip-flop constant in between and no longer have the consistency of just one type of risk-profile cycle flows.


Track changes every day or not at all



Lets outline why tracking risk profiles needs to be done every day, and 3 times (as mentioned in the first article) ideally and not just once. Because it's the first two days of cycle change that matter the most.


When cycle flows shift, one can minimize the losses (if having trapped positions, or wrong carry expectations) the most on the first two days. Any week that we extend after that (once the turn is already obvious to everyone including Cramer) that is already too late. Because now you are either bagged or had to cut for big losses, or one still had expectations of prior market behaviors of different cycles, but the cycle has already changed.


Therefore those changes need to be tracked across any day (since there often are no pre-hints to when flows will change) so when the ignition day shows up you are ready. To cut and reposition, and reform the expectations on markets.


When risk-ON kicks in:


-Bull trends durations expand (in days of lasting)


-Frontside squeezes have more volume and bigger % deliveries


-Tickers are less likely to finish deep in red by the end of the day, and that includes all markets


-Small cap assets will get action and over time outperform large cap assets (deeper into the cycle)


When risk-OFF kicks in:


-Bull trends durations shrink and are more likely to flop quickly


-Frontside squeezes don't get far in % (making for safer shorts)


-Tickers are more likely to finish deep in red by the end of the day


-Small-cap assets will see significant dry periods and get little or no attention, while safety flows into larger market-cap assets will start taking place



This difference in expectations tells us that one should NOT have the same trading plan for both cycles!


If behaviors variate significantly (which they do) then to maximize the edge one needs two different trading plans more or less:


-Target depth on profits should be different (when risk-ON expands higher targets for longs)


-Risk tightness should differ (tighter on shorts when risk-ON present, looser on longs)


-Swing frequency on the long side should differ (much more swings in risk-ON cycles and avoid or very little in risk-OFF as most of the swings will not deliver or under-deliver on the long side).


Above should be the blueprint for no matter what ticker or asset class one is trading or investing in. And that includes investing as well because, in the era of flip-floppish flows, one has to reposition the portfolio on the investing side much more frequently!


Commodities example Q1 2022: Do you think you can just blindly long supercycle in commodities at the start of 2022? You would be wrong. That cycle deflated completely in Q2 2022. If you did not switch portfolio exposure, you are carrying major bags. That's because we started 2022 with risk-off which ignited commodities (Ukraine-Russia) but later as inflation started to top out and central banks started hiking rates, that did not play out for commodities.


Large cap equities example Q1 2023: Or let's take longing large caps in early 2023 because of the risk-ON start of the year. One might assume it's as easy to just invest into a bunch of large caps randomly and have a set-and-forget approach. Well, you would likely get no return as most large caps struggled (unless you have selected the 10 biggest companies in SP500 that did well).

One had a chance to sack longs in Q1 of 2023 when banking issues began, triggering risk-off. That was the signal to shift positions and it would outperform most of those that did not do so, as through most of 2023 we had very few strong risk-ON periods present (November as the cleanest one).


If you get sloppy on longs, you better hope that the market will be in risk-ON mode most of the year. Just through the chance of luck. If that does not happen and you have a year like 2023 with too much of risk-OFF cycles, the hands-off/random approach will deliver bagged positions or just losses. Remember, its risk-ON cycles that rescue your bagged longs, and why you need them (since we all have some bags every now and then).


This explains, why being close to cycle rotations is the way to avoid that. To avoid getting trapped, and cut the losses fast, especially on swings or investing positions. And the same applies to short-term trading as well. To pick right directional bias for short term trading risk profile analysis should be the top of pyramid, when it comes to prioritization of reasons. Above anything else.

Breaking down 2023 cycles



Let's break down the entire year in terms of market cycles. As you can notice from the image below, the year was quite 50-50 in the positioning of cycles with some strong risk-ON and some strong risk-OFF presence.


That translated into SPY being trapped inside of range for a good chunk of the year excluding the fact that the overall trend was higher. But we should not use SPY to translate just how impactful the changes in risk profile flows of 2023 were. The lesson is much clearer when we focus on equity assets and different equity indexes but we exclude the SPY. Because the outperformance of SPY was highly driven by just a few strongest stocks, it creates a dimmed picture of reality. If we use IWM (small cap index) and a bunch of non-tech large cap equity indexes, we can notice the sensitivity to risk flows changing much clearer. Especially when all of them are combined. But for sake of clarity on image only SPY was included below:


As one can see, the year started well, but soon after January the troubles began. Risk-OFF kicked in as the banking issues (SVB) began, it weakened credit and weak credit was the basis of further equity weakness, along with some haven flows (into USD and yen) that also capped equities pretty well.


Gold and risk on/off relationship (tricky)



A good example is also that in the risk OFF cycle in February the gold has sold off even though safe haven flows were actually somewhat present (gold is highlighted with violet color on chart). And that could be explained through the progressive strength of the dollar. Even if safe haven flows are there, but the dollar is strong, gold will usually not perform well. That shows us the value of risk profile analysis and why one shouldn't just be long gold "because of banks having issues". It shows that to structure good trade on a short-term basis, one needs to calibrate through multiple views (often conflicting).


An example of risk-OFF kicking in (which sometimes can be bullish for gold if driven by geopolitics such as in October) but generally if USD is strong gold will struggle. Unless it's a geopolitical event, which tends to lift gold higher even as the USD is rising as well! This is a very important dynamic to understand and place within the context of trades, especially for those trading gold.



Below is the risk of the cycle from February. This was a deflationary cycle with a "bust" of banking sector news therefore leading to the dollar gaining value (fiat currencies gain in deflationary projections) meanwhile that is negative for gold as gold gains most in inflationary news cycles. And keep in mind, that those are all forward projections. It's not as if you get 2 weeks of bad news for banks and that somehow creates deflation and starts to spiral lower CPI data. It's what market participants are pricing in advance as expected. That is why such a reaction. We can see that when USD rises gold will struggle unless there is an inflationary component behind the news.

Below is the opposite of the above example (more tricky one). Same risk-OFF environment (bad for equities) but the dollar is holding stable, meanwhile, the gold has rallied huge. This was the October of Mid-East event ignition, which is geopolitical and therefore inflationary in forward expectations. Which has led to significant rally despite USD holding ground, as safe haven combo and potential for inflation from conflict erupting had to be priced in gold.

The above example shows that not everything is the same in each cycle, and no analysis is static. For example its not as simple as, Risk-OFF=gold higher for sure is not how one should apply it. Because a Risk-OFF environment can tank gold prices too. It's about the context of the entire situation. However, typically risk ON/OFF for equities is clearer than it is for gold. Using the above gold example just to highlight how two same cycles (risk OFF) can deliver X asset to go in opposite directions due to underlying differences in inflation/deflation market projections by the biggest funds. Both gold and oil share such dynamics.


Additionally, risk-ON cycles (when everything is going well for the economy) are actually not bad for gold prices by default either. Because it depends on dollar movements a lot. It's common that people assume gold does well when things are bad in the economy. But lets check the 2023 behaviors of gold prices specifically in risk-ON cycles only.


As we can see above, gold did great in each risk-ON cycle. Equities also did great (less of a surprise of course). At the same time dollar was weak in each of those cycles. This gives us some highlights on what truly is driving gold prices on a short term basis. And that "gold goes down when things are improving, or gold goes up when things are bad in the economy" is a heavily oversimplifed view of gold price behavior.



Isolating bond yields spikes versus equity performance in 2023



Lets isolate bond yields against the SPY/SP500 performance to highlight just how important tracking yields can be to project whether SPY has the potential to rally or not over the next few days. The hammering impact of yields on SPY is significant IF yields spike a lot (in short time).


Highlighted in the example below:


Think of yields spiking as a mechanism that forces markets to reprice equities of corporations lower, assuming a lot of them have debt exposure. As yields rise the debt burdens eat into balance sheets more, creating the need to revaluate those equity assets lower (hence SPY decline). However, this effect is most noticeable when yields move fast and quickly, not slowly over a long time. Over 2023 we had many situations of those quick spikes that influenced all markets as a result. Credit is one of the most important underlying foundations for markets.


So to not track the yields as one is trading large caps is quite unacceptable in 2023. It might be acceptable in 2017 when yields were flat and we had 0% interest rates. As inflation and rates rise, markets become sensitive to the changes in credit markets. Therefore in 2023 one can no longer be a lazy equity trader as one might be in 2017 not paying attention to what's happening in other key asset classes, especially credit markets.


The key takeaway of this 2023 and 2022 yield vs SPY performance should be to always pay high attention to whatever is THE KEY story of markets. What is THE story? What most social media influencers are talking about? Never. It's always what the biggest guys care the most about, those managing fund portfolios and governments themselves (on the credit side).

The story of 2022 and 23 is therefore about credit weakness via rising interest rates and inflation. The selloff of bonds. And that story got established quite quickly into early 2022 and never ended until the end of 2023 (so far). This means that regardless of what instruments you are trading you have been impacted by this KEY story highly. Because all assets have been sensitive to rising yields as the relationship above between SPY and yields shows.



Isolating yields versus Forex instruments


Now someone might be Forex and not an equities trader. Is yields "story" impacting your analysis? For sure, just as much as equity traders might be.

Let's highlight impact yield but on the EURUSD side for FX instruments rather than equities. However, let us use yields dumping instead of spiking as a signal (the same just in inverse of prior above example applies, not bearish but bullish signal):


Briefly from a fundamental perspective: When credit improves (and yields drop) the safe haven assets will get sold off often (USD for example) which causes EUR to outperform USD as the market is seeking higher yields in emerging markets or G8s which are non-US economies. Therefore bidding EUR vs USD.


Sharp changes in yields can create significant clarity to EURUSD FX pair performance and the trend projections for at least a few days once the yields have those large changes. Is there value in understanding the fundamental analysis of economies when it comes to trading FX? Well above example highlights a significant reason why yes.


Remember that meanwhile as most FX traders are obsessed with tracking news and self-interpreting news to pick the direction of a pair, very very few retail traders pay any attention to bond yields (a boring asset class that only institutions are supposed to track? Well, you would think wrong if that's the conclusion).



Hot equity sectors can ignite in both risk-OFF and risk ON cycles, but selectivity in risk-OFF is very important



While it is true that many more hot sectors (for obvious reasons) will trigger in risk-ON cycle, it is also often the case when risk-OFF ignites very sharply it can create hot sectors because of it. Such an example is 2022 commodities when inflation started to spike. Risk-OFF cycle therefore created inflation and a rise in commodity prices. The rise of commodities (such as oil) ignited equity sectors exposed to energy production, example below. As result many stocks in energy space had significant runs amidst hot sector mania: HUSA, IMPP, XOM, CVX, etc...

This leads to the fact, that it's not so much "don't think of longing equities in risk-OFF cycles" its more about, do you know what the current risk-OFF cycle is about? What is triggering it, and what is moving inside of it? Because that will dictate if opportunities might show up or not but especially important-in which sector?


For example, early 2022 risk OFF triggered a major selloff in SPY and most large-cap sectors, except the commodity sectors. That was the "hot sector" in play which offered plenty of long opportunities.


This brings us back to the title "Selectivity in risk-OFF cycles is very important". What is meant by that is possibly one of the most important aspects that any stock trader should understand.


In risk-ON cycles one can throw random darts at things and those darts just stick. Random dart into smallcap ticker, chasing long into squeeze. Then throwing another random darts into a large cap overextended name that just keeps going higher. Both positions eventually work out fine. Sloppy, poor risk management and no particular setups. Fine. You will NOT get away with such behavior and actions in risk-OFF cycles.


When risk OFF is in play most sectors will struggle. Some will plunge hard. And very few will do okay or great. This means that selectivity is that much more important than what kind of long exposure one wants to have and what sector/ticker is the right one to pick.

Personally, it took me a long time to understand that part, and many traders struggle with implementing this correctly.


Should you just avoid equity longs when risk-off is present? Rather than trying to pick the right sector and be super selective, surely is easier to just avoid longs fully?

Well not really, because one expands market knowledge the most when everything around you is collapsing but you are holding onto that one tiny green flower that stands up in the middle of entire chaos. To be able to do that without being a fluke teaches you significant lessons of how the market decides in which sectors the capital flows and how to shape quality market ideas.

There is always something in play on the long side of equities including in risk-OFF cycles, however, the pool of quality opportunities is very narrow.


This leaves us to conclude that one should spread out in terms of portfolio and swing exposure when the risk-ON cycle is active. Whether venturing into crypto altcoin longs or Bitcoin itself, large-cap stocks in this or that sector, or perhaps G8 currencies (not USD).

And when risk-OFF is active, one needs to tighten portfolio exposure significantly. It is not acceptable to be loose and sloppy, and heavily exposed across multiple sectors with prior long positions (especially if out-of-the-money position) as much of those positions will turn deeper into red likely during risk-OFF.



Risk-OFF started. Should i cut my swing long on GME? Nah ill just stick with it and lets see what happens.



Track the cycles therefore and ignitions especially to navigate your exposure. The key is to recognize cycle changes fast! Once you are late and recognize cycle change 2 weeks after its ignition day, chances are positions are already well in red and you will just cross your fingers and hope for the best because cutting all of those losses would be too painful. That is why from a practical trading perspective recognizing cycle rotations EARLY is key. Else cycle analysis becomes just academic material at best. Which sadly is how most macro education is aligned with. Late and only hindsight. Typically because most macro "experts" are still learning and puzzling pieces of global asset flows just as you are. They might be a bit more ahead of you, but still not ahead enough, and missing key chunks. That is why so few apply cycle analysis on point (accurately) and well.


If you wish to check just how much above is true, use the first image of 2023 all yearly cycles, and go check in hindsight how many of the experts that you value were right on time giving you correct suggestions to rotate your exposure in key asset classes that will benefit in each cycle. Check videos in hindsight and go find those that were very accurate in early identifications. By the way, it doesn't count if you isolate a person who for 10 years repeats the same story. Only those count that are adaptive, as only those can be tested on their knowledge of market timing!



Smallcap stocks from the perspective of the Risk-ON cycle versus Risk-OFF



As mentioned many times already, small-caps are highly cyclical, and the performance/behavior differences between the cycles can be significant.


Framework to keep in mind for smallcap stocks:


Risk ON:


-1. Multiday runner chances increase (especially with the presence of the hot sector)


-2. higher chance of hot sector ignitions and more high % long deliveries on squeezes


-3. higher liquidity with tighter spreads and more volatility. All of which leads to higher RR on both longs and shorts. Ideal environment.


-4. The frequency of gappers will increase noticeably when risk-ON is present. More opportunities for everyone.


-5. Duration of multiday runners are extended (past minimum 1-2 weeks to well beyond 3 or 4 weeks)



Risk OFF:


-1. Multiday runner's chances significantly decreased (unless the hot sector is present)


-2. lesser chance of hot sectors showing up, and less consistent long opportunities


-3. lower liquidity, wider spreads often as a result, and lower ranges on tickers. All of which leads to lower RR on either longs or shorts. Reducing the size and expanding the stop loss size is not a bad idea in such times to address the change in liquidity (you can't be too tight on risk if the ticker has a very wide spread for example).


-4. frequency of gappers will shrink noticeably when risk-OFF is present. Therefore less opportunities not just for bull-biased traders but also bearish biased ones.


-5. Duration of multiday runners are shortened (to minimum thresholds of just a few days)



What we can notice from the framework above is that this change in cycle actually impacts our trading expectations and edge in multiple ways, if we only just focus on multiday runners, let alone everything else.


For example, if one is long only swing trader in smallcaps, for which MDRs (multiday runners) are your primary edge feeding source, behaviors of tickers will shift in each cycle.

If one is swinging too much and too frequently tickers in risk-OFF cycles, too many of those will not turn into great runners. Trades will under-deliver too often.

If one increases long exposure and frequency of how many tickers longs are placed on within the risk-ON cycle that can lead to better maximization of edge. It is highly common that swing traders pay no attention to cycles and have consistent and same trade exposure at all times through the year! 10 swing trades in account on January, 10 in March, 10 in May, etc. Meanwhile cyclicality in risk-OFF months will create stack of losses. That is how edges are degraded in markets. Same exposure with no selectivity=randomness.


To use conceptually two different methods and compare:


Strategy 1: Trader who is not paying attention to cycles and longs tickers at any random point of the year with exactly the same aggression and expectations. This leads to some months being great and some terrible. Because the cyclicality exposure of strategy will create randomized results due to the nature of risk ON/OFF delivery changes.


Strategy 2: More skilled trader adjusting expectations to cycle changes can adjust strategy each day or week. Increasing more positions in risk-ON cycles early on, and reducing long exposure much more when the risk-OFF cycle is present in global markets.

Strategy 2 would as result improve:


-reduce the number of stop-outs


-increase deliveries of high % movers


-clean up messy bagged positions more


The reason why so many smallcap trades constantly complain about the cyclicality of having really bad months, is all coming from well yes you guessed it- the cyclicality of markets itself. And by cyclicality i dont even mean smallcaps. Its big markets risk-ON/OFF cyclicality that drives smallcaps cycles. If we care about origin of the flows, which we should, we know where to look first before geting clues in smallcaps flows.


Market cycles are not static, and performances between each cycle differ significantly. You must STOP thinking about bull and bear markets. That is beginners' talk. Start thinking about risk-ON and risk-off cycles. Why?

Because even if you have 1 month of market decline within risk-OFF and that impacts trading performance significantly, most market pundits and participants would not call a 1-month decline in SPY a "bear market". It takes many risk-OFF cycles stacked up together before most market participants would say "Hey this is the proper bear market". But by that time when you have 3 risk-OFF cycles together if you did no adjustments to trading your performance already took a huge hit. As was the case for many in 2022. Risk ON/OFF are basically micro cycles of bull/bear markets.


Any trading approach in small caps is impacted by risk profile changes in global markets. Regardless if you go long or short, or trade MDRs or d1 gappers or you name it.


Traders think that you can just cowboy the markets with a hands-off approach but that is typically a short short-lasting story. Over the long run what flushes out traders from markets are always significant cycle changes that last longer than you expected. So take cyclicality seriously.



To highlight the above, let us show small-caps from the perspective of the May Risk-ON cycle versus August Risk-OFF cycles:


First of all, August was one of the driest months in small-caps. It was inside of the global risk-off cycle. Is it surprising? Not really.

Meanwhile, May was relatively hot with plenty of big squeezers and the presence of a hot sector (AI). May was inside the global risk-ON cycle.

Check the first yearly 2023 cycle image to re-confirm that near the start of the article.


We can see that everything established above as basic framework expectations between each cycle holds true between those two examples.

Multiday runners were much more active in May than in any part of August, by a significant margin. And % of high parabolic squeezes was significantly tilted to the advantage of May, meanwhile in August, there was much less if any.


Conceptually the difference is as such between those two months:


The above is not uncommon but rather common. The differences in deliveries and "scare mode for short sellers" are day and night between risk-ON vs risk-OFF cycles. As we mentioned risk-OFF can also trigger big runners but is much less likely than such a thing happening in a risk-ON environment where almost always something will squeeze 1000%. And those tickers are often trainwrecks for sloppy short sellers. If you just pay close attention to risk-profile analysis you might be able to dodge those heavy runners better on the short side.


This might sound a bit strange but we can use another data point to validate the above. I save screenshots, patterns, and observations on a daily basis for small-caps. If we just compare both folders of each month there is a significant difference in activity. That says a lot by itself especially once placed in the context of risk ON/OFF cycles:


Not convinced? Let's check another two months as a different example, and again one being risk-ON cycle and another risk-OFF global cycle presence:


Notice the difference in activity of saved material, because when there is plenty of activity the amount of saved data will be higher.


Again that is not hindsight analysis or "interesting observation". If you track cycle changes well and are somewhat good at timing them, you can anticipate the activity levels of small-caps to a certain extent. And not just activity, but especially performance differences and how that will impact your edge.


For example, in the May Risk-ON cycle, we had a CXAI 1000% squeezer (intraday). We also had that in many risk-ON cycles of 2020 and 2021 (SPI would be another ticker off the top of my head). Specifically- intraday 1000% squeezers, not just multiday runner that turns into 1000% squeezer because those do happen in risk-OFF cycles as well. It's intraday ones that are specifically common only to risk-ON much more.

Another viewpoint would be November where we had VVOS intraday 1000% squeezer. November was also a risk-ON cycle. MSGM was another 1k% squeezer in the January risk-ON cycle.


Let's overlap all those tickers via risk-profile flows to check that:


As you can notice all those three tickers are located inside risk-ON cycles. Most of those intraday 1000% squeezers are. But that is not really the key takeaway. The key takeaway is, that in almost all risk-ON cycles something goes 1000%. If you are a short seller that is why you would want to pay attention to the cycles, to create proper cautious expectations. In drier risk-OFF markets those heavy "dangerous" squeezers are much less frequent, creating a more loose risk environment for short sellers.



Dilution activities from the viewpoint of cycles



As a result, there is also some correlation between offering and dilution activities on those tickers, depending on which cycle is present at the time. For example, risk-ON cycles have increased in correlation to dilution activities because they bring fresh liquidity and higher prices to tickers. On the backside of strong cycles often dilution activities increase. And in the middle of risk-OFF cycles, they might decrease. Whether that is a useful observation or not can be debated.



Be adaptive and not too single asset class-focused



Because different asset classes will perform at their best in different cycles, it's a good idea to be asset agnostic. And to jump into the asset class that suits the current ignition of risk profile the most. However that approach does come at significant time expense as one has to devote a lot more of study time. It is what it is, no shortcuts to cycles.


When risk-ON ignites:

-look for opportunities in small-caps and altcoins of crypto (smaller market-cap assets)

-look for opportunities on the long side of Forex pairs (EURUSD, GBPUSD, MXNUSD, etc...)


When risk-OFF ignites:

-look for opportunities in large cap stocks on the short side

-look for opportunities in the long side of USD in Forex (shorting EURUSD, GPBUSD, etc..)



Duration of cycle and impact on selecting the right asset class


It is also key to discuss the current duration of the cycle and how this should impact our choices of the right assets. Typical performances of assets will differ based on how deep into the cycle you are.


Early risk-ON cycle (infant cycle):

-Large-cap stocks move first

-bonds and credit improve first

-everything else with medium or smaller market cap size will not respond YET


The middle and later stage of risk-ON cycle (matured cycle):

-Large-cap assets lose competitiveness versus smaller-cap assets. Smallcaps and mid-caps start to outperform, once the market gets used to prolonged duration of risk-ON cycles. This tells us that after some point (10 plus days, but generally closer to 20 days) transition might start taking place. Markets lose interest in larger/safer instruments and instead start to push more capital and activity into smaller market cap assets which have higher return potentials.


To use conceptual example of how small and mid cap assets will often outperform larger caps in the middle or later stage of the risk-ON cycle:


Partial reason why the above dynamic happens is because institutional capital needs first to see the red carpet being laid out and confirmed that in fact, this is not just an overnight party, but rather a potential sustained event. That is why risk-ON cycles need to be established for a while before key capital participants start to liquidate safer assets and push excess capital into riskier lower-cap tickers.


One of the clearest examples of the above dynamic is the biggest risk-ON cycle of the past decade in between 2020-Q2 2021 where one can study such dynamic between Bitcoin and alts and LCs / SCs of US equity markets. Both with very clear lessons.


We can however also highlight some of that present in the latest November risk-ON cycle from the perspective of AMD (large cap) and a few smallcap stocks. AMD was well well-established runner as soon as risk-ON began, however, it then later into matured cycle started to stagnate meanwhile smallcap activity upticked and created overperformance versus AMD.

Example of how the focus of market makers and key funds shifts after the risk-ON cycle is established for a while. Smallcaps on image below (AMD on separate image under):



What you can observe from the above example is that small-caps activity starts to uptick significantly with higher liquidity only deeper into risk-ON cycles. Very unlikely to happen at the start of the cycle. That information should be applied correctly to expectations on tickers. Being still somewhat bearish in the early stage of the cycle is valid. Going for early longs on multiday runners in the early stage of the cycle is a must to apply. The longer the risk-on cycle is established the more likely you are late with MDR longs. Because the cycle might turn.


We can also use AMD as an example of how the ticker had a strong influx of activity and higher volatility early into the risk-ON cycle (as one of the leading large-cap tickers) and then towards later stages the returns of upside moves started to stagnate, meanwhile small-caps outperformed significantly at that point. That is what was highlighted with conceptual example as well a little higher:



While this is just single example we could list many more from this year, as same dynamic happened in each cycle between large caps in play and smallcaps that later on showed up.


Let's highlight another example from the perspective of small-caps and how the January risk-ON cycle impacted the behaviors of smallcaps. Again use the first image in an article about yearly flows to see how this fits into January risk-ON expectations. What is noticeable in the below image is that most heaviest squeeze action only ignited deeper into the risk-ON cycle, and the fact that many tickers turned into multiday runners. Both of those are specific risk-ON behaviors and a proper edge to play on.



Use the above timing ratios to determine whether you should watchlist "today" large-cap stock, or prioritize smallcap stock on the watchlist instead. Or prioritizing the watchlist of currency instrument because of cycle depth reason above the smaller market cap equity or other instruments.


A classic mistake is traders only focus on a single asset niche and they force opinions and trades all the time, every day. Because when you only look through tunnel vision your asset class of choice has to provide the answer & gains every single day, yet cyclicality tells us that is very illusionary as quality of trades will drop if such approach is taken.


While someone might say that developing edges and strategies for multiple markets is very difficult, keep in mind that most that attempt this are doing it without the context of risk-profile flows. Which leads to creating dry strategies based on technical analysis outside of any market cycles. Leading to failure eventually. Any strategy that does not forward address the ON/OFF switch based on the correct market environment will likely fail.


As long as you start with cycles, and then base your strategies for each asset class from that route, it should be much more organized and direct. Because one isn't going to try creating "evergreen" strategies this way. If you start with the fact that "everything is cyclical" your strategy in the first place will be developed for a particular cycle only, and not doing what most in markets are trying to do: creating strategies for one asset class that is supposed to perform excellent through every random month of the year that you apply it. This is likely a route to failure. Shape strategies for each cycle and you have a much higher chance of surviving in the market.


Bitcoin vs alts in Risk-ON November



The above image illustrates the same as smallcap/large cap relationship that we highlighted above. When risk-ON cycle ignites market bids Bitcoin first the most (and ETH). Only after cycle is established for while then alts start to gain traction. And in more mature risk-ON cycles thats where alts really start to outperform Bitcoin. The same applies to crypto as it does to equities.



Conclusion


Hopefully, this has provided some insights into just how important it is to track risk ON/OFF changes in markets and how they impact different asset classes with very similar impacts. In my view, this is why risk ON/OFF analysis is the absolute top of market analysis as a whole. It impacts the hierarchy of all other market analyses.


To study this one has to stretch out and get curious about many different markets (even if you have no interest in trading them). Risk profile/cycle analysis cannot be understood from the perspective of a single asset class of choice.



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