Giving back yesterday’s gains

Stocks opened lower, giving back all of yesterday’s gains and then some.  Good news one day, bad news the next, typical action for a consolidation.  The interesting thing to watch is if this consolidation is the bottom of the range, or if it is a pause halfway down as part of a three wave correction.  As I shared earlier, I expect at the very least we’ll retest the lows of the range and more likely than not make new lows before this is all said and done.  The question is if the lows will be 1290, 1280, 1257, or lower.

For the time being the market is reading too much into each headline coming out of Europe or China.  One day the market is excited and the next it is dejected.  No doubt the news will go both ways for a while and as a result the market will get whipped around. One thing to put all of this in perspective is no matter what the economy is doing, there will always be both good and bad headlines at any given time.  What really matters is how the market responds given what the masses are inclined to gravitate toward.  Is the market optimistic, pessimistic, or confused?  Right now we are in a choppy consolidation because the market is swing back and forth between bullish and bearish biases.  While it seems like the market is chaining its mind on a daily basis, what is really going on is neither the bulls nor bears have the strength to sustain a breakout and after a flurry of bull or bear activity, it quickly fizzles and the market swings back the other direction.

Breaking the upper side of the recent consolidation shook out many bears and tempted premature breakout traders to go long.  But this was nothing more than highly speculative buying and there is no substance to these traders as they come and go with the prevailing wind.  To sustain a move higher we’re going to need buyers with conviction that are willing to hold for extended periods of time.  With all the headline risk facing the markets, many of these longer-term traders are waiting out the uncertainty before committing more capital to the markets.  Many of these savvy traders have the view they would rather buy several percent higher and forgo those profits if it means they have less risk of the market reversing on them. And this is why each breakout fails to gather the critical mass it needs to continue higher.

CRUS is trimming yesterday’s strong breakout gains.  This demonstrates the risks associated with buying even the strongest stocks during a correction where very few stocks can overpower a declining market.  And even the best performing stocks only notch modest gains during a correction, giving a very low risk to reward.  As pointed out during our monthly IBD meetup, if WON makes all his portfolio managers hold cash during a correction, what makes us think we can do better?  The goal isn’t to make all the money, but to capture a chunk of highest-probability profits when the wind is at our backs.  Using leverage on the way up and sidestepping the pullbacks will produce great results even when buying late and selling early.  And back to CRUS, yesterday’s breakout is highly noteworthy and the stock should be added to a ready list for consideration when the uptrend resumes.

Stay safe.