The indexes rose nicely in early trade, a welcome sight given the streak of six consecutive down-days and 11 losses in last 13 trading sessions. Is this finally the bounce everyone has been talking about, or the inevitable up-day that is part of most larger sell-offs? And lets not forget many of the previous down-days were up early too. Of course the difference today is the markets are up far more than those more modest rallies that quickly fizzled. Either way, I think buying today’s bounce still counts as catching a falling knife and is best avoided by any prudent trader. One day does not make a trend.
The news driving today’s rally is word from European leaders they want to keep Greece in the Euro. Glad to hear that Euro problem is finally solved and we can move on. (sarcasm) If I were a wagering man, which all stock traders are, I would say a sizable portion of today’s rally is driven by short-covering. By itself short-covering is unsustainable without real buyers stepping in to support the new move. From here we need to wait and see if a meaningful number value buyers are ready to venture back in.
On Friday the S&P500 closed under 1300, while not an important technical level, it is a key psychological mile-marker and no doubt got people’s attention. The 200dma is the next major target at ~1280 and also coincides with some technical levels dating back to last fall. 1257 is another major psychological milestone on the horizon since it represents giving back 100% of the Q1 rally. Will we bounce off of this region? Break through it and then bounce? Or will it simply be a speed bump on the way to lower prices?
Sentiment in the market is getting precarious and any further declines creates the very real risk of triggering a irrational, fear based sell-off. People have been able to rationalize most of the recent decline as normal pull-back and and part of a healthy refresh of the phenomenal Q1 rally. But what was supposed to be a 3-5% correction is quickly becoming uncomfortable. Regret is mounting, as is the fear of greater regret by allowing additional losses to pile up. No doubt today is a relief rally for those still holding, but to have the market turn back around and make new lows will push many traders to the point of selling simply to make the pain of stop. And of course that whoosh-down will be the capitulation point that often signals market bottoms.
Part of the reason I suspect we haven’t seen a mad rush for the exits yet is the powerful Q1 rally has left many people sitting with winning trades even in the face of the recent sell-off. As any of us know, it is one thing to see profits dwindle, yet an entirely different feeling to watch your account go into the red. Maybe this lack of significant panic selling is because many traders are still up for the year and this is acting as a stabilizing factor keeping the markets more rational during this correction. But it is something to be aware of if we continue to fall and that pushes more traders into the red for the year.
FB is providing a lesson in market sentiment and supply and demand as the most assured IPO pop in history is plunging 12% instead. And no doubt FB could have crashed on Friday had the underwriters not dumped a ton of into the name in order to avoid a an ugly first day sell-off. Yet again the market proves that the best move is to trade opposite of what everyone else thinks. Of course this doesn’t mean the stock is dead and it could easily rally after forming an IPO base.
And so this brings us back to the indexes again. How many people are saying the market is set up for a great short vs how many say the sell-off is overdone and ready to bounce? There are no numbers to gauge this in real-time so we need to go with our gut based on the clues around us. Now this is simply my opinion, but it seems like not enough people have been demoralized yet to justify a turnaround from this aggressive sell-off, leaving me highly suspicious of today’s rally. No doubt today’s strength could continue for a couple days, but that is how a sawtooth decline looks. But regardless of bear or bull outlook, the disciplined CAN SLIM trader is waiting for a follow though day to avoid falling prey to a sucker’s rally. And when we do get that follow through day, we need to be ready to start buying the market. Often the more reluctant you are to buy the follow through day, the more likely it is to work.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.