Hello trader,

Following the prior week’s late sell-off, dip buyers returned in force this week, pushing the benchmark S&P 500 index up nearly 3.0% by Friday’s close.

With the benchmark S&P 500 now in a period of seasonal weakness, the extent of this week’s rally was a bit unexpected.

Coming into what had the potential to be a seasonally turbulent week, though, I was excited to see some of the trade ideas being presented by our Masters’ Club instructor, “8-Ball.” 

As he starts sharing his favorite weekly ideas with Total Alpha members, “8-Ball” had a couple of low correlation ideas on his list this week.

I’m about to share with you why these stocks are currently less sensitive to a correction in the event of a broad market pullback, and why they may be poised to build on the positive gains they’ve already delivered this week.

Trade Lesson: Correlation

In the investing world, correlation, a statistical term, measures the degree to which two or more instruments (i.e., stocks, ETFs, futures contracts, etc.) move in relation to one another.

Correlation is presented on a scale of 1.0 to -1.0, where a correlation of 1.0 means that the instruments being compared move in perfect relation to one another, a correlation of -1.0 means that the instruments move in a perfect inverse relationship, and a correlation of 0.0 means that there is no relationship at all.

Correlation is a tool many traders and money managers use to diversify their portfolios, especially when there may be an anticipation of increased volatility in certain areas of the market.

One example of when correlation analysis would become important is during a period when a combination of technical indicators might be indicating that recent upward price movement in the major indices was about to witness increased headwinds.

In situations like this, a trader would reduce the number of holdings in areas of the portfolio that have a high correlation to the broader market.

The trader could either put some of that money in cash or spread it to certain areas of the market that do not trade with a strong relationship (i.e., a high correlation) to the major indices, and therefore would be less at risk of witnessing a correction along with the broader market.

Trade with the trend, but select trades that reflect your system’s risk tolerance

As traders, we must trust our process, and if our process is telling us to be cautious there’s nothing wrong with trading in a manner that carries less risk.

Even though I entered this week’s trading generally bullish on the market, I did have some concern about the potential for elevated volatility in the face of sluggish seasonality.

The chart directly below sheds some light on this, where we see the S&P 500’s average performance during this week has been quite negative over the past 20 years.

Figure 1

As every market participant will eventually come to learn, no indicator works all the time.

In this case, the S&P 500’s history of showing weakness during the time of year simply isn’t playing out as it has over the past 20 years, on average.

Trust me when I tell you that no one ever gets the market right 100% of the time.

If you trade with the uptrend and reduce bullish risk because your system led you that way, you must be too hard on yourself if the market outperforms your expectations.

If you’re feeling nervous about the market, look for ideas that are less sensitive to the S&P 500

While all the ideas presented by “8-Ball” at the start of this past week had favorable chart setups, the two that stood out to me were ContextLogic Inc. (WISH) and SunRun Inc. (RUN).

That’s because of the diversification (i.e., lower correlation) they offered during what I felt might be a choppy week this past week.

Let’s take a closer look.

ContextLogic Inc. (WISH)

Fundamentally, WISH did $2.5B in rev last year and has $1.8B in cash with no debt on the books.

In addition, according to Twitter sources, both Amazon and Alibaba recently offered $10B to buy the stock at a market cap value of $6B.

Technically, the chart directly below reveals that the stock witnessed a positive cross of its 13-day moving average above the 30-day moving average on 06/17, which signaled that a rally similar to what we witnessed this past week could occur.

This occurred as the MACD indicator, which was showing positive divergence against the lower price lows of early June pushed above its midline this past week, issuing a buy signal.

Finally, the study on the bottom panel of the chart shows that this stock, which has less than one year of trading history, has traded with a weak inverse correlation of -0.46to the S&P 500 over the trailing 63-days (1 quarter).

Next, there’s RUN

I came into this week long the Jan 55 calls, looking to turn these into a bull call spread by selling higher strikes against.

From an institutional standpoint, Morgan Stanley set an aggressive price target near $91 with the stock currently trading at $52.

Technically, there have been a number of constructive developments of late.

Specifically, after the recent rally above what had been a heavily fortified resistance area at $50, the 50-day moving average is now starting to slope higher for the first time since the start of March.

When combined with recent rotation by the 14-day RSI momentum indicator into a bullish regime, this action is indicative of an intermediate term trend that is in the process of transitioning bullishly.

Since trend transitions can take some time to develop, I’ve decided to go all the way out to January with my calls.

Finally, the study on the bottom panel of the chart shows that this stock has traded with a weak inverse correlation of -0.33 to the S&P 500 over the trailing 63-days (1 quarter).

Bottom Line

These are the kinds of chart setups I like to see when looking for opportunities where the trend can continue to develop in my favor, in stocks that are less sensitive to any broader market turbulence that might be on the horizon.