When it comes to the right approach to stock market investing, Ned Davis hits the nail on the head in his classic 2014 book Being Right or Making Money.

Davis emphasizes the difference between “being right,” by forecasting the direction of the markets, or “making money,” which is achieved through the development of trading techniques which deliver consistent profits even when forecasts are inaccurate.

Over the years, I’ve learned that relying on the latter, especially in uncertain markets, is much more rewarding and is the key to building long-term wealth.

Take the current market. The prevailing wisdom on Wall Street is that the Federal Reserve’s next rate increase, expected to be 25 basis points on the fed funds rate on May 3, will be the straw that breaks the camel’s back. Forecasters are tripping over themselves predicting the next market crash. Traders are skittish.

It’s this fear of the Fed that has often created a strange trading environment in which the intraday price volatility is mind boggling while by the end of the day, little has changed. I described the inner workings of this dynamic in a recent interview with John Persinos.

The details of that interview describe the murky inner workings of the stock and options markets in the age of algorithmic trading (AI). I’ll have more on AI trading below.

Yes, there are reasons to be concerned about the economy. For example:

• The banking system is in trouble;
• Job cuts are rising;
• Business confidence is falling;
• There is the potential that the U.S. will default on its debt if Congress and the White House can’t agree on a new debt ceiling; and
• There are plenty of unknowns out there as the geopolitical sands continue to shift.

Yet, the stock market, despite its frustrating volatility within a spellbindingly narrow trading range, refuses to crash and burn.

As a result, investors who have built positions in sectors of the market that have not fallen apart aren’t faring badly in this quirky environment.

Focus on the Present

A great way to sort out the macro action in the markets is reviewing the market’s breadth (the difference between rising and falling stocks) as displayed by the New York Stock Exchange Advance Decline line (NYAD) and the price action of the S&P 500 index (SPX).

Read This Story: Wall Street’s Soothsayers: Reliably Wrong

The NYAD offers a non-distorted view of what’s happening inside the market because every stock on the exchange gets one vote in determining the direction of the line, regardless of is market capitalization.

When the line rises, it shows there are more stocks gaining ground than those whose price is falling. That’s a bullish trend and one in which it is worth owning stocks despite what the market forecasters are saying.

I also like to see what’s happening in SPX, although its short-term trend can be distorted by a large move in one or more of the companies whose shares are most heavily weighted in the index. For example, a large move in a company or a group of companies like Microsoft (NSDQ: MSFT), Tesla (NSDQ: TSLA) or Alphabet (NSDQ: GOOGL) can exert an undue effect on the whole index.

Note the big gain in Microsoft after a bullish earnings report on 4/25/23. This gain in MSFT pushed SPX higher on a day where the market’s breadth was flat (NYAD, above).

What’s Happening Now?

Currently, both NYAD and SPX are portraying a neutral market. Neutral markets are often profitable if you pick the right sectors.

Consider the current status of the NYAD:

• It’s trading in a short-term consolidation pattern;
• It’s testing the support but not breaking below its 50- and 200-day moving averages, all reassuring signs until proven otherwise; and
• It has made higher highs and lower lows since bottoming out in October 2022, the textbook definition of an uptrend.

Certainly, things could change in a hurry. But until NYAD breaks below the 200-day moving average, the long-term trend is up.

We see a similar picture in SPX where the index remains in six-month trading range dating back to October 2022. As with NYAD, we have a bullish relationship to the key moving averages.

The Accumulation Distribution Indicator (ADI) had been in a steady uptrend since December 2022 until 4/25/23 when traders got spooked on news of a slowing economy. A rising ADI is bullish because it signals short sellers are exiting their bearish bets.

On the other hand, On Balance Volume (OBV) remains flat. That’s a sign that buyers are not totally convinced that the worst is over. Note that when the short sellers knocked down ADI on 4/25, OBV remained very stable. Buyers aren’t panicking.

The picture that emerges is one in which short sellers are generally leaving the market while buyers are not totally convinced in the ability of the whole market to rally, but are also not panicking. That means that money is still flowing into certain sectors of the market.

And that’s where the profits will come from.

Smoother Sailing Through Sector Selectivity

The effect of investors’ insecurity spawned by the Fed is that money is flowing into select areas of the market. Nowhere is this more visible than in the housing sector, where the SPDR S&P Homebuilders ETF (XHB) continues to outperform the general market.

Let’s contrast XHB’s performance to that of the AI Powered Equity ETF (AMEX: AIEQ), an ETF which touts itself as “The first actively managed ETF to fully utilize artificial intelligence as a method for stock selection.”

You can see that the performance of the robot-powered ETF is lagging that of XHB, a sector ETF which invests in homebuilders and related areas.

There is nothing glamorous or futuristic about any of the stocks in XHB. It’s just bricks and mortar. Yet, it’s having a great year because in the real world, the supply-and-demand equation for housing favors homebuilders.

There is nothing to forecast here. You can just monitor the earnings announcements for the companies in the ETF and keep up with the price charts of individual housing stocks and the goings-on in the housing sector.

No hocus-pocus here. Homebuilder stocks continue to beat expectations and offer steady guidance. XHB keeps rising.

My point is that AIEQ is built on forecasting, as the algorithms which are used to find stocks for its portfolio are programmed based on the programmer’s expectations of the future. Because trading algorithms are partially programmed to respond to news events, their actions are often based on the prevalent forecasts put forth by Wall Street. Those are mostly gloomy. AIEQ is hovering near its 52-week lows.

Ignore the Noise. Focus on the Present.

The Fed is clearly squeezing the economy. And it is plausible that one or perhaps two more rate increases could sink the economy into recession. The stock market’s popular pundits and large brokerage houses are forecasting this and large numbers of investors are investing based on this premise.

They may well be right, and the risk of a recession and its potentially negative effect on the stock market should not be ignored.

But investing is about maximizing the risk/reward ratio. Thus, when short sellers are scrambling, such as they are in SPX, it’s a telltale sign that the worst may be over. Moreover, those investors who put in the time to find those areas of the market which are still working in their favor are more likely to be rewarded during periods of uncertainty.

The forecasters say that AI is the future and that homebuilders will crash when the Fed raises rates in May. All I can say is not yet.

At the end of the day, I’d rather make money, than be right. And the way to do it is to make trading decisions based on sound principles instead of sometimes foggy forecasts.

But maybe you’re still nervous about current market risks. If you’re looking for a way to generate steady income with enhanced safety, consider our premium trading service, Rapier’s Income Accelerator, helmed by our income expert Robert Rapier.

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