Click HERE to return to the full Inside TradeSmith issue.
Click HERE to Watch (15:16 min. watch)
Mike Burnick, Inside TradeSmith: Hello again, everyone. I’m Mike Burnick with Inside Trade Smith.
And joining me today, a special guest who needs no introduction. We’ve had him on here before, Jonathan Rose of Masters in Trading.
Jonathan, how are you? It’s good to talk to you again.
Jonathan Rose, Masters in Trading: I’m doing great, Mike. Thanks for having me.
Mike: Absolutely. It’s always great to catch up with our different analysts and writers around the country.
And, you know, this is really going to be an interesting conversation because you and I are on the same page with this topic, what we call the “Age of Chaos,” for short, that we’re in — you know, all this political uncertainty, of course, the tariffs we saw, the market yo-yo all the way down and back up, and you know, then we’ve seen some geopolitical conflict, trade wars part of that, and then, of course, a hot war we saw with Iran there for a brief period. And all of this leads to elevated market volatility that just won’t go away.
Now, you see this creating a lot of what you call Divergence trading opportunities. In fact, more of these opportunities than you’ve seen at any time since the financial crisis way back in 2008. Tell us a little bit about your outlook there and what exactly is a Divergence trading opportunity?
Jonathan: Sure. So, just a little background about myself. I’ve been trading for 27 years now, and I’ve spent the majority of my time living in Chicago at the different exchanges. I’ve worked at the Chicago Mercantile Exchange, Chicago Board of Trade, and I really learned how to trade options when I was a market maker on the floor of the Chicago Board Options Exchange.
And I’m a big believer in free markets. I’m a big believer in the trader’s true role is really to keep markets efficient.
The market needs traders. It adds liquidity. So, the trader’s role is to keep things efficient.
So, my thought process in looking for opportunities: I have never throughout my career just looked at something in isolation. I’ve never, for instance, looked at the gold market and said, “Do I think gold’s going higher or lower?” Instead of that, I look at the metals complex, and I’m always looking at strength and weakness in the metals complex. And to me, that’s a divergence — things that are correlated, that move together, that all of a sudden break apart. The role of the trader is to keep things efficient.
Mike: Right, so it’s basically the divergences you’re seeing and that you take advantage of and you’re trading. It’s basically a breakdown in the normal correlations or the normal relationships of, like, stocks to bonds, for example, or gold to silver or something along those lines.
How are you able to take advantage of this with shorter-term trades? Is it as simple as going, let’s say, short stocks and long bonds or vice versa, or is there more to it than that?
Jonathan: Well, there’s definitely more to it than that, but ideally — and there’s a pretty good example — it’s solar companies.
So solar companies, U.S.-based solar companies are going to be more correlated than a U.S. solar company and a solar company from China. But overall, the solar industry is going to be correlated together.
So, look at trades, if I want to trade the solar industry and if I want to buy companies in the solar industry, I’ll start analyzing all the liquid companies and then see where I can find the best value.
What company is maybe dragging it along while the other ones are outproducing? The ones that are outproducing — why are they outproducing? Oftentimes, it’s just pure supply and demand or maybe it’s like a First Solar, where the street’s more familiar with that name.
Sometimes you can find some quality off-the-beaten-path names. So that’s where I believe I have an edge, but also where traders have an edge to help keep markets efficient.
For instance, if the whole solar industry is up 50% for the year, every single solar company is going to be up a minimum of 35%, I hope, right? Some of them might be 70%. You might have the outlier that’s 100%, but what I want to look for is — why is that only up 30%?
Mike: Yeah, it makes sense. You know, if you think about semiconductors, for example, you know, you’ve got Nvidia, which is head and shoulders above the rest. It’s the clear leader in the group. And then other semiconductor stocks are actually down here today, because they’re in a different position in the market.
So, you look at those relative relationships, say, between Nvidia and some other stock, correct?
Jonathan: Yeah, well, Nvidia is kind of a beast of its own because it’s such a gargantuan and almost a monopoly now on what it does.
But something really cool to look at is just Nvidia relative to the QQQs.
They’re extremely correlated. Sometimes I feel, because I’m always watching options volume, sometimes the options volume in Nvidia is 10% of the overall market. So sometimes I feel like we’re living in Nvidia’s world. But that’s a great thing to watch — Nvidia relative to the QQQs, the QQQs relative to the SPY.
Interesting what’s happening right now, which I’ve never seen in my career at all. The Nasdaq is so freaking expensive relative to small caps. Like small caps — you guys holding small caps know that they’re dragging along. They’re gonna have their day.
But right now, that’s the biggest divergence between the Nasdaq and the Russell 2000 in the last 10 years.
Mike: Yeah, yeah, that’s right. You’re right.
Also, U.S. stocks measured by the S&P 500 for years were leading international markets, but now that divergence is kind of switching back. It’s that, you know, rubber band analogy, if you will.
You know, Europe, for example, underperformed the U.S. for years. But this year, European markets are up, you know, double digits. And we’re basically flat.
Jonathan: That’s exactly it. That’s what we do. Sometimes the U.S. is strong, sometimes global is strong, sometimes Brazil is strong. We look at Brazil, which is heavily influenced by China.
So, when tariffs start, Brazil names are gonna get hit.
I’m a big believer. Something I’ve learned throughout my career is nothing happens in isolation.
You know, if oil’s up a ton, something else is falling. Everything is pushing and pulling off one another. If oil’s up a ton, maybe the oil refinery stocks that have been beaten up, maybe they’re good buys, but there’s always something.
I use this analogy: When I’m looking for trades, it’s like when you go to the beach, if you have a dog and you have a dog on this 30-foot leash, but you can stake him into the ground, he can run 30 feet in a 360-degree circle, but he’s never running further from that.
That’s the analogy I use where I’ll find an investment, but I want to be able to tie down the risk. And that helps me do that, and we call those Divergence trades.
And you can really do that in every sector.
Mike: Yeah, you could see them in every sector, domestic, internationally, and in commodities as well as stocks or bonds. But I’m glad you brought up Brazil because earlier this year, you put on a divergence trade. I believe you were long Mexico versus short Brazil at that time.
And, I mean, you had triple-digit gains in that trade alone, and you can’t really find those kinds of trades unless markets are volatile, like they’ve been this year, right?
Jonathan: Absolutely. The volatility is what really creates opportunity. When the markets are just going up and the VIX and the fear index and volatility is going low, everyone’s happy. Everybody’s making money, but where traders really shine is when volatility picks up.
And Mike, the trade — it’s actually a pretty cool trade — because we literally did that trade April 1st, right before Liberation Day. Getting short Brazil, figuring it’s gonna get dragged down from China because China controls Brazil, really is the biggest investor, and at the same time getting long Mexico. And we were able to profit on both sides of those trades where Mexico actually got really strong and Brazil got crushed right after that tariff announcement.
Yeah, it wasn’t very good.
Yeah, like I say, “Luck is the residue of good design,” — Branch Rickey said that, but it’s always a quote that I love.
Mike: And let’s talk a little bit about what you’re referring to as the trade of the decade here. And I don’t want to give away the whole candy store, but you’ve noticed a kind of historic divergence between gold and silver. So, tell us a bit about that.
Jonathan: Well, the biggest trade that we’ve ever had at Masters in Trading — I had somebody who had a $44K account and he ended up turning it into, I think, $180K. We covered that all on Tuesday. It’s a really cool story.
Right after COVID hit the wires, volatility skyrocketed, and volatility creates opportunity because it dislocates markets.
What happened was gold shot straight up. Silver went straight down. And the gold-silver ratio is the longest tradable relationship. And silver soon snapped right back in line with gold, which was incredible how quickly it happened.
But five years later from that time, gold is now historically expensive to silver. So that’s a really cool trade, and that’s something I really dive into when we do the program on Tuesday, July 1.
Mike: OK, interesting. I can’t wait to learn more about that.
You know, when it comes right down to it, Jonathan, it seems like almost any trade you could place is a divergence trade, right? Current market conditions now — because of the volatility, all the high economic uncertainty that we see right now — it’s really kind of the perfect environment for these divergence trades, isn’t it?
Jonathan: We need the volatility — and that’s what we have right now. And it’s even better because, in my opinion, there are artificial divergences because they’re really news bombs. It’s not like the natural ebb and flow of the market. There might be a news report that sends the solar sector down 40%.
And that’s a great opportunity to potentially buy what’s cheapest in that sector and maybe sell something that didn’t come off. It’s a common-sense opportunity once it’s explained, which I feel is like that Brazil–Mexico. If you could explain that trade, that might resonate with people — before Liberation Day — like, OK, that makes sense to me. That’s somewhere we’re comfortable risking.
Mike: Right. Yeah, we’ve certainly seen our fair share — more than our fair share — of those tape bombs in recent months haven’t we, with all the tariff news and the most recent was just the news about Iran launching missiles at the U.S. after giving the U.S. warnings that they were coming.
And you would think crude oil would go through the roof. It did just the opposite. It plunged in value that day.
So, it just goes to show you how this volatility is here to stay, and you can really take advantage of that with these divergent trades.
Jonathan: Well, it’s interesting you say that because when these news bombs hit and stocks or commodities make big moves, they snap back. They just do.
And often we see things that we’re like, “Oh, I’d love to do that trade, but it feels so risky.” That’s why we want to do that trade, but we can buy something — but we look to tie it down like that reference I made to the silly dog on the beach.
But that’s what you do when things get really volatile. You’re not just crossing your fingers by buying Nvidia. Maybe you’re buying Nvidia because you’re selling something else.
Mike: So, your kind of hedged that way, both ways.
Jonathan: It’s a soft hedge. It gives you more confidence in the trade, and sometimes you’re able to make money on both sides of the trade.
But really, we’re looking for dislocations in the market, and then we expect them to come back anywhere from, you know, a day to 60 days or something like that. Things can happen pretty fast, but in volatile markets they present all the time.
Mike: It seems like things are happening faster and faster every day to me.
You’re right, yeah. Well, Jonathan, you also have a special workshop planned for next week, I believe, July 1st, where you’ll be giving some of these real-time examples of divergent trades and why they’re really the perfect type of trade for today’s volatile markets. Tell us a little bit about your workshop coming up.
Jonathan: Sure. The workshop — we’re gonna go over exactly what divergence trading is.
We have a mantra that I say over and over. And we have a community — a discord community — and it’s “Education mitigates risk.”
The more you learn, the more you train yourself, the more you know about the markets, the more open you are to just following different markets — not risking more money, just learning. Because we work damn hard — really hard — for our money. We might as well learn before we’re gonna put any risk on.
So, that’s why you’ll come. Everybody will come away learning something. And I didn’t realize how much of it — because this is what I’ve done throughout my entire career — but it’s a different way of trading than people are used to.
Mike: Yeah, exactly. And that’s coming up on Tuesday, July 1st, folks. You can get more details about Jonathan’s workshop just by following the link that you’ll see below here on this page.
Well, Jonathan, thanks so much for catching up and spending some time. I just love talking shop with you.
Jonathan: This is great. Hey, if I can throw one more thing in — every single day that the markets are open, I do a live show, and it’s a Masters in Trading Live. It’s 11 a.m. Eastern time. It’s on my YouTube channel.
So, check us out. If nothing else, we all get on there and say good morning and literally just talk about the market and try to add value for you guys in any way I possibly can.
Mike: That’s a great, great way to catch up on what’s going on in markets on a daily basis. I love it.
Jonathan: Thanks for having me, Mike.
Mike: Jonathan, have a great weekend. We’ll talk to you again soon.
Jonathan: Fantastic. Great, thanks. Bye.