Sep 292012
 

S&P500 daily at end of day

The market continued its indecisiveness and has chewed up anyone trying to anticipate the next big move.  Don’t fall for the market’s tricks and stick to sound analysis of supply and demand.  The market often convinces you that you are wrong before finally proving you right.

MARKET BEHAVIOR

Markets gave back a big chunk of yesterday’s relief rally.  Seems a bit of the bi-polar temperament is returning to the markets, but these 1% dips and rebounds are nothing compared to what we saw just a few months back.  While it feels dramatic because the markets have been so docile lately, keep everything in perspective.  The market continues to be relatively calm and the sky is not falling in spite of what you see reported in the financial press.

Selloff volume has been greater than rebound volume, but that is not unusual for selloffs when everyone is on edge.  Stealth corrections often do more damage than ones everyone is talking about, and without a doubt this pullback is front and center.  In-your-face corrections flush out the weak holders and rebound in short order.  It is the stealth corrections where everyone is lulled to sleep by complacency that have the potential to put a large dent in your portfolio.  All the chatter and fear in the markets today means the selling will climax and we’ll find our footing.  Remember, complacency is what allows bigger corrections to happen and I don’t think the market is complacent yet.

MARKET SENTIMENT

The market never wants to be easy and the long trade was getting a bit too obvious.  And of course if the long trade is too obvious, then a reversal becomes the second most expected trade by the cynics.  But to fool bulls and bears alike, the market throws in these whiplash head fakes to draw in both sides and then proceeds to humiliate and demoralize everyone.  Only after everyone is crushed and given up will the market reveal its true intentions.

There is renewed fear over Europe, yet again, but seriously, this story is three years old!  These recycled headlines are not the stuff that moves the market in major ways.  New and unexpected news moves markets, not something that has been over-analyzed ad nauseam.  Free and efficient markets are the most effective discounter of known information ever conceived and all of this noise is already priced in.  Anyone claiming what is going on in Europe, Asia, or the US is new and unexpected is deluding themselves.  Who is actually surprised that young and unemployed people in Greece and Spain are pissed off?  Really?  Common, give me a break.

So what does that mean for a trader?  Market reactions to these old headlines are not going to stick.  There are plenty of reasons the markets can head lower, but it won’t be any of the ones people are talking about right now.  Weak holders can get shaken out because of the headlines, but that selling dries up quickly and it becomes a great buying opportunity for the bold.  We will have a correction, just not yet.  The nervousness is too pervasive for the market to selloff in a material way.  We need more complacency before that happens.

TRADING OPPORTUNITIES

While there is still upside in this move, that doesn’t mean we have to sit through all these ulcer inducing gyrations and head fakes.  It is far easier to watch volatility this from the sidelines after cashing in decent gains from the earlier, easier, and more profitable portion of this rally.  Fools hold out for top dollar and only a gambler enjoys these market whips.  Buy early and sell early are the only way to beat this game and sleep well at night.  It is not wrong for an investor to hold for longer periods of time, but we are traders and our nimbleness is our greatest strength.  It would be a shame to give up the only advantage we have in this game.

Stay safe

 Posted by at 12:27 am on September 29, 2012
Sep 272012
 

 

S&P500 daily @ 3:21 EDT

The obvious short over the last couple days is putting the hurt on a lot of premature bears.  The best trade is often the hardest trade.  Yesterday the hardest trade was buying the market.  And that turned out to be the right trade.

MARKET BEHAVIOR

The indexes staged a relief rally after five consecutive down-days, including the largest single decline in three months.  All of Bernanke’s QE-finity gains were given back as we fell to the 1430 trading range from early September.

Yesterday’s price action was a healthy pause to let investors regroup and make intelligent, rational, and informed portfolio decisions, as opposed to Monday’s crashing market that took out countless autopilot stop-losses on the way down.

No doubt a lot of today’s strength is aggressive shorts getting blown out of the water, yet again.  The time when the market sells off and the shorts are afraid to touch it will signal the real deal.  Each bear-trap moves us one step closer to that day.

MARKET SENTIMENT

We need to get in the head of the market if we want to figure out where we are headed.  Everyone who bought the Bernanke bounce was either chased out of the market or is/was underwater.  The rally was fairly obvious by that point and anyone jumping on the bandwagon was late to the party.  QE3 was the good news everyone was hoping for and after it was announced it finally felt safe to be into the markets, but as we witnessed, it was actually the most dangerous time to buy in the last three months.

It is basic human psychology combined with supply and demand dynamics that drive this market paradox.  As humans, evolution conditioned us to take emotional cues from the people around us.  If other people are freaking out, then it probably means a tiger entered the camp and even if we don’t see it with our own eyes, our survival depends on following the crowd to safety.  Same goes for complacency.  If no one else sees anything dangerous, then it is okay for us to relax too.

While this herding mentality works great in the wild, it will get your head cut off in the financial markets.  Supply and demand dynamics make it such that these rules are flipped upside down.  We can safely ignore what everyone is panicked about, but we have to fear what no one else sees.

Financial markets move based on new buying or new selling.  When the crowd thinks one-way or the other, they as the aggregate have already placed their trades and are simply waiting for other traders to come in and continue moving prices their direction.  But by the time the crowd is nearly unanimous in their views and everyone feels the most safe, all the buying has already occurred and there is no new buyers left to continue the move.  So just when you feel most comfortable is when the market is about to reverse on you.  And of course the opposite applies, when the market feels most risky is when it is often the safest to buy.

So how do we use this information?  Looking in the rearview mirror it is obvious that the safety of QE-finity was a mirage.  But we can’t trade last week, so we need to focus on what will happen tomorrow.  These five days spooked the market pretty good and brought the fight back to demoralized bears.  Riots in Greece and Spain are making everyone nervous.  The market doesn’t feel safe anymore.   And as it turns out, the best time to buy stocks was over the last two days when it felt like everything was falling apart.

An easy way to gauge market sentiment evaluating how you feel?  Does the market feel safe?  Does it feel scary?  Are you excited to buy the dip, or fearful of more downside?  If you’re relatively normal, your feelings will mirror the majority of the market.

Looking forward, the dips that scare everyone and invigorate the bears can safely be bought.  The dips that bears are afraid to short and everyone else assumes are just another great buying opportunity will turn out to be the real sell off.  After this week’s vicious bear-trap, a lot bears are likely to go into hibernation and that means we need to be far more careful of the next selloff.

TRADING OPPORTUNITIES

Looks like aggressive bears who shorted the market are getting squeezed out today.  This bounce certainly stopped the downside momentum and put many bears on the defensive.  There will be a bigger corrective wave in our future, but it usually takes a few failed attempts before one finally sticks.  More psychology is involved in why this happens, but we’ll save this for another day.  If you can’t wait, check out my March 13th post on the Psychology of a Top.

We’ll probably top 1475 in coming weeks as calm and complacency return to the markets.  You can stay long for the time being, but the more confident you are in your positions, the more seriously you need to think about selling.

Stay safe

 Posted by at 3:25 pm on September 27, 2012
Sep 262012
 

Markets are lower, but seem to be finding a floor, preventing a wider cascade selloff.  Have we triggered enough automatic stop-losses to clear the deck and resume our rally?  Sticking with the trend remains the high probability trade, but the returning volatility is going to make for a bumpy ride.

S&P500 daily @ 3:05 EDT

MARKET BEHAVIOR

The selloff continues as we dipped to 1430 this morning.  It’s been a while without a material selloff and the ride was getting a bit too easy for the longs.  Everyone knows the market goes two-steps forward, one-step back, but each time the step-back happens, it catches everyone off guard and they panic.

Every rally must come to an end, and so will this one.  But the thing about trends is the high-probability trade is always sticking with the trend because it continues countless times, but reverses only once.  W could be at the start of this rally’s reversal, but that doesn’t change the higher probability that this rally will continue.  From a risk/reward perspective, I’ll gladly be wrong every once in a while if it means I can be right ‘countless’ times in-between.

And of course timeframe is everything when talking about the direction of the market.  What the market does in the next ten minutes could be different than what it does later today, this year, or the next ten years.  Bears could be right over the next two days, but bulls could be right over the next two weeks.  This is why it is so important to take profits when you are right because often if you wait too long, you end up becoming wrong.

MARKET SENTIMENT

Europe is crying wolf again and the market is spooked by the street riots.  As investors we have to ask ourselves if this unrest will affect the rate of economic recovery?  This isn’t the first protest and likely won’t be the last.  Ultimately this won’t have much impact, but the market is nervous and people by nature are 2.5x more risk adverse than greedy.  This is why the markets selloff at the first hint of risk.

The biggest headwind for US stocks right now is a strengthening dollar.  Since currencies are relative, a weakening euro translates directly to a strengthening dollar.  That doesn’t mean the dollar is in good shape, just that it is less bad than the euro right now.  How this affects the equities markets is through a strong inverse relationship between the USD and the US markets.  Just one of the many reasons explaining this correlation is a weak dollar boosts the stock prices of US companies with international exposure because it increases the relative value of their overseas sales and profits.  And of course the opposite applies when the dollar increases, like we are seeing right now with the unrest in Europe.

What will ultimately determine where this dip goes is if selling cascades, or if it climaxes and exhausts itself.  It all depends on the resolve of the larger group of holders.  Will the selloff persuade previously content longs that they need to bailout?  Or will the selling pressure from nervous holders, late buyers, and early shorts fail to trigger something bigger and the market will bounce after this smaller group is done selling?  It is impossible to gauge how contagious fear is in each situation, but under most instances cooler heads prevail and value buyers jump in when prices fall to attractive levels.

TRADING OPPORTUNITIES

The easy trade is coming to a close and making money is going to become more of a chore as the volatility returns.  There is lots of debate whether this is just a dip or the start of a correction, but the great thing about being a trader is we can cash in our profits and let the market figure this out while we watch other bulls and bears get turned into minced meat.  We don’t always need to be in the markets to make money, and in fact it is less stressful to capture profits by selling into strength and then waiting for the next great trading opportunity.

Some people want to hold big winners for their entire run, but that is no longer trading, it is investing.  And if you want to invest, then you need to be as thorough and disciplined as a Warren Buffet.  If you want to hold a stock through good times and bad, that is like getting married and you better know your stock as well as your spouse if you want to hold through each base and correction.  This includes reading annual reports, every article written about a company, talking with customers, suppliers, and anyone else who can give you an insight into the growth prospects of the company.  This is far easier to do with consumer product companies like CMG, AAPL, and NFLX.  If you are naturally an early adopter, look for the new companies and products you are most excited about.  Find the cult following and huge growth opportunity Wall Street doesn’t know about yet.  But remember, to hold through good times and bad, you are marrying the stock, so you better have a lot of conviction that a dip is just a dip and not something more.

Stay safe

 Posted by at 3:11 pm on September 26, 2012
Sep 252012
 

S&P500 daily at end of day.

Markets had their biggest down-day in several months, but don’t jump on the correction bandwagon just yet as the market hates being obvious and will most likely chew up both bull and bears with head-fakes before revealing its true intentions.

MARKET BEHAVIOR

The markets opened higher, but started selling off in late morning trade and the slide accelerated under 1445 by late afternoon, violating previous support at 1450.

Does this mark the end of the run?  Most likely not.  Climax tops reverse quickly, so the 10-days of sideways trade at 1460 largely preclude this outcome.  Even if the market is toppy at these levels, many reversals take the shape of a double-top or a head-and-shoulders, meaning we could easily make new highs in the near-term even if the ultimate resolution is lower.  (Although we could be completing the head portion of a reversal if August is the left shoulder)

Selling or shorting today’s weakness is the obvious trade and often the obvious trade is the wrong trade.  But today’s 1% decline is noteworthy because it is the largest decline in at least three months.  This return of volatility could be the early signs of turmoil in the markets, which often precedes a reversal in direction.

As seen in the accompanying chart, the market continues to trade comfortably inside the previous uptrend channel established this summer.  We broke above it briefly with recent Bernanke pop, but have clearly retreated back within the range.  It is too early to write the rally’s obituary, but the warning signs are mounting.

MARKET SENTIMENT

It sure feels like the market is trying to selloff, but each time big money comes in and props it up.  The million-dollar question now becomes, what is ‘smart’ money doing?  Is it accumulating shares at each dip?  Or is it quietly selling to the ‘dumb’ money chasing these new highs?  People think price and volume magically give clues on this, but the truth is the market is always perfectly symmetrical because for every seller you need a willing buyer.

What ultimately determines the direction of the market is the depth of available buyers and sellers at a particular level.  Will we run out of buyers at this level first, or sellers?  Up to this point, the supply of sellers has run short and is why prices have been bid up to four-year highs.  But this is a big move since the June lows and the higher we go, the harder it becomes to find new buyers.

I still sense there is slightly more skepticism than optimism in the markets, and as we all know, people trade their portfolio according to their opinions.  The skeptics are light the market and the optimists are heavy the market.  While this balance was far more skewed a few weeks ago and lead to the explosive upside we’ve seen, the scales have become more balanced recently and this is why the bears are finally able to exert more downward pressure on the markets today.

Lacking a strong sentiment skew, the market could break either way, but more often the market tends to overdo a trend before reversing and so far it doesn’t seem like this rally has been overdone from a sentiment point of view.  But the probabilities are becoming more balanced and there is less of an edge to being long than there was a few weeks ago.

An interesting idea came from a WSJ article on Monday quoting several money managers who are allegedly thinking of closing their books at these levels and coasting through the 4th quarter.  But here is the thing, big money managers are notoriously secretive in positioning of their portfolio because they don’t want anyone to front-run their trades, so why would these guys start gushing to a reporter about what they are about to trade?  It doesn’t make any sense unless 1) they have already sold and closed their books for the year or 2) they are intentionally trying to spook the market so they can buy in at lower levels.  Either way, this sentiment by several money managers shows greed has not overtaken the market and big money remains cautious and reluctant up here.  No doubt the market could fall under its own weight if buyers fail to show up, but the fair number of skeptics remaining provides ample fuel for a continued move higher if a rising market forces them to start chasing.

The direction is a tough call here because of the recent run up, but I suspect there is more upside left in this move even if that includes a modest pullback to flush out all the weak holders who bought at the tail lend of the recent run-up.  Remember, the market is never easy, so buying after the obvious rally was a mistake and most likely so is shorting the obvious start of the correction.  I have little doubt the market will chew up both bears and bulls before this is all said and done, so wait a bit before jumping in on either side, unless of course your portfolio enjoys the feel of the market’s meat grinder.

INVESTING OPPORTUNITIES

As I’ve been saying every day for the last couple weeks, keep doing what is working, but don’t get greedy and be prepared to take your worthwhile profits off the table.  It is far more profitable to sell into strength and buy weakness than the other way around.  Sell when you don’t want to sell and buy when you don’t want to buy.  That is the fundamental core of the contrarian trading.

Stay safe

 Posted by at 5:43 pm on September 25, 2012
Sep 242012
 

Markets are down modestly, but support is holding up.  Continue holding for the time being, but if you are not in the market, don’t come rushing in now because we are closer to the end of this rally than the start.  The media and many traders are debating the upcoming election, but how the market reacts might surprise you.

S&P500 daily @ 2:47 EDT

MARKET BEHAVIOR

Another red day in the markets, but we are still holding above 1450.  This level has provided solid support and remains an encouraging sign.  Most often buying dries up quickly following unsustainable rallies.  Holding this level for more than a week shows real support and a continuation from here is more likely than a reversal.  The pattern of modest and controlled pullbacks is continuing and time will tell if this consolidation is building yet another launching pad for the next surge higher.

MARKET SENTIMENT

To date the market is largely ignoring bad news and giddy over modestly good news.  Don’t fight the tape when the market is clearly inclined to go higher.  Now this rally can’t go on forever and we are in the later innings, but so far the sellers are impotent to drive the market lower, meaning the high probability trade remains to the upside.  Only after all the bears and cynics have given up do we need to start worrying about a pullback.

A couple of key psychological mile markers on the horizon are the end of the third quarter on Friday and the election in just over a month.  I addressed Q3 in Friday’s post if you are interested.  The election is the next monumental thing after a few regular data points like the employment report in two weeks.

Conventional wisdom says a Republican win would be better for the economy and stock market, but the truth is the market is politically agnostic.  We’ve had phenomenal rallies under Democrats and crushing bear markets under Republicans, so it isn’t as simple as claiming one side is better than another.  The truth is all the market really craves is a stable business environment where it knows what all the rules are.  Uncertainty is the real demon that kills rallies because investors fear the worst when presented with ambiguity.

The pre-election poling is competitive, as is the case for most presidential elections, but I have yet to see a single poll giving Romney the edge and everything so far shows this is Obama’s election to lose.  And no doubt the market is already pricing in an Obama win since the market is always looking ahead.

But what will surprise most people is how a market expecting a Democrat win is rallying.  While Obama’s taxes and regulation are anti-business, at least everyone knows what the rules of the game are.   Romney is promising to “repeal and replace” healthcare and financial regulation, meaning all those bitter, partisan debates from the last couple years will be coming back under a Romney win.  And to further muddy the waters, Romney is promising to fire Bernanke, making the future of US monetary policy another wildcard.

Many will try to argue with me on this, but the market’s attitude is indisputable.  Clearly the markets are rallying into what looks to be an Obama reelection.  And if you need more proof, look at the reaction to the Supreme Court upholding Obamacare.  What was a crushing blow for the small-government, low-regulation, low-taxes movement has been a boon for the stock market as we are up 10% since the June 28th ruling.  The stock market preferred the certainty of Obamacare over the uncertainty of reopening the health care debate.

The key to making money in the markets isn’t thinking about what it should do, but understanding what it does.  In this case, the market clearly favors status quo over “repeal and replace”.

TRADING OPPORTUNITIES

The rally is consolidating, but all good things must eventually come to an end.  We probably have more upside left, but are closer to the end than the beginning of this run.  Be ready and willing to take worthwhile profits and wait for the next buying opportunity.  This isn’t about making all the money, just the highest probability money.  It is a fool’s game to try to pick the top, so never regret selling early.  Take your profits and move on.  It is what the most successful traders do and is what we should do.  Bulls make money, bears make money, but pigs get slaughtered.

Stay safe

 Posted by at 2:57 pm on September 24, 2012