Trickle Down Froth-o-nomics

This post Trickle Down Froth-o-nomics appeared first on Daily Reckoning.

We’ve seen this show before…

Just four short years ago, stocks and crypto were ripping to new highs at a rate that alarmed many conservative investors.

Due to Covid’s warping of the space-time continuum, December 2020 feels like it was just yesterday and eons ago at the same time. In case you’ve memory-holed the second half of the year of lockdowns and Covid panic, I’ll set the stage…

The weather was getting colder as winter approached in late 2020. Many areas of the country were heading back into lockdown mode as Covid cases spiked. The country had almost made it through the first year of the pandemic. But a new class of stock market speculators was starting to get anxious.

Stuck at their white-collar work-from-home jobs, these young bucketeers started bidding up every crazy stock and crypto they could find. Message boards, including the now-infamous “Wall Street Bets” on Reddit, attracted mainstream attention. And social media personalities like Barstool Sports founder Dave Portnoy live-streamed the opening bell as they bid up random tickers, hoping to land the next 10-bagger.

Of course, stock market seasonality helped fuel the flames. It was the perfect time for a year-end melt up, everyone was stuck inside, and they had cash to burn. Stocks soared and the early 2021 NFT bubble began to inflate, as well as the options-fueled squeezes in meme stocks like GME.

Does any of this sound familiar?

The pandemic might be over. But we’re seeing history rhyme this month as a holiday market boom rivaling 2020’s Covid bubble begins to unfold.

Crypto has taken center stage early with Bitcoin pushing toward a $100K breakout extension. Alt-coins are flourishing. Heck, I even joined the ranks by grabbing some DOGE as it rallied 300% off its lows to set up for what could be an even bigger breakout

“Meme stocks” might not be the biggest beneficiaries of the speculation this time around – but many forgotten stocks and sectors are catching a bid and running in the current market environment. The smaller, the better!

Just look at the evolution of AI mania as the year has progressed…

Trickle Down Froth-o-nomics

NVIDIA Corp (NVDA) led the artificial intelligence charge during the first six months of 2024, breaking out in early January and bolting higher by more than 175% into late June. NVDA slowed down in the summer after hogging the spotlight (and most of the gains). But the big semis started to slow down in the summer. And while NVDA and the semis have picked up the pace, they aren’t the only game in town.

The risk-takers have moved down the cap scale to the smaller, more speculative artificial intelligence names. These are the stocks that are ripping higher in this environment!

C3.ai (AI) has jumped nearly 65% since mid-November. BBAI has gained as much as 150% over that same timeframe. And SoundHound AI Inc. (SOUN) has exploded 190% off its early November lows.

Artificially Inflated

AI speculations soar into melt-up season

To be clear, these stocks didn’t suddenly firm up and start to run because of any fundamental changes or a surprise news event. We’re simply seeing traders rotating into the smaller, more speculative names in the industry.

I don’t know what will happen with these stocks once the music stops. That goes for these AI names — or any other small, reenergized stock that’s posting a huge rally right now.

But I do know how markets work — and parabolic rallies like these rarely lead to clean, sideways consolidation. There will be downside action when the rally ebbs. Some of these stocks will reset to logical new support levels and then build bases at those prices before continuing higher. Others will retrace the entire melt-up move and slowly die on the vine. There is no other way!

This doesn’t mean you have to completely avoid the melt-up darlings.

But you do have to adjust your expectations…

The Wrong Kind of Risk

One of the biggest hurdles new traders need to clear is learning how to deal with different market environments.

When you first begin to develop your unique trading strategy, you will naturally want to use it consistently to book regular gains. The problem is that consistently is often replaced with constantly. Newer traders regularly force trades in less-than-ideal environments because they can’t tear themselves away from the action. They’re chasing breakouts when breakouts aren’t working, or they’re buying stocks and sectors that are out of favor for one reason or another.

It’s not that they’re taking too much risk – they’re taking the wrong kind of risk.

This misunderstanding can even work against traders who, on the surface, believe they are acting conservatively. If you’re a swing trader attempting to play a small move in mega-cap semiconductor plays when the smaller AI names are working, you’re taking the wrong kind of risk. And it’s costing you!

As I explained last week when I detailed my uncharacteristic meme coin trade, I’m more concerned about the trades I’m not involved with right now. In melt-up conditions, the biggest risk for traders is ignoring these impressive rallies.

I routinely review my trading performance, going back over the previous six to twelve months to see how I’ve fared. During this process, I’m not very interested in counting my winners. Instead, I want to review where my losses came from, what mistakes I made, and where I can improve.

Again, this process isn’t about win rates or victory laps. It’s about pinpointing where I could have made different decisions, especially as it relates to emotional blind spots I might have had at the time of the trade.

Next week, I’ll dig into some of the lessons learned during my 2020 Covid trading campaign. I’ll show you how a great trade doesn’t always yield ideal results, and reveal what you can do to maximize your melt-up gains.

Stay tuned…

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