The markets are trading in a tight range for the second day in a row. So far this is showing good support at these levels as the swing traders are unable to push the markets lower at the upper end of the trading channel. They are selling into this strength anticipating the next swing lower, but the market is holding up nicely. The recent rally chased off all the bears and tempted in a few bulls on the breakout, but adding further gains to this breakout will give a larger number of cautious bulls the confidence to wade in, pushing the market higher.
Of course we do have some downside risk if all those bears sitting on the sidelines decide to try again and pile on the shorts in unison. If this happens, the key level to watch will be the 50dma to see if the bears can finally break the back of this rally. But so far the bulls are still in control and the bears are licking their wounds.
Looking at the bigger picture, even thought we are close to 52-week highs, there is a large amount of bearishness in the markets. There is a lot of cynicism toward this rally and that is part of the reason the market is holding up so well. All of these cynics have already sold or shorted the markets, meaning they can no longer pressure the markets. And in fact they are built in buyers if they end up covering their shorts or are forced to chase a rising market. This is exactly what we saw this winter as the markets had the best first quarter in decades.
But the thing to be careful of is oftentimes the bears are right, just early. Success in the markets is all about timing, so early is the same thing as being wrong, but just because the market is holding up doesn’t automatically mean the bears are simply paranoid and wrong. NFLX was one of the most heavily shorted stocks last year at $200. While there was still a lot of upside left in the name as it eventually rose to $300, any bull would have done himself a favor to at least acknowledge the risks the bears were bring up.
The market is holding up very well right now and we are trending higher in the face of all the negative sentiment. Conversion of bears to bulls could fuel a powerful rally, but any bull at least needs to recognize the risks bears are bringing up.
The markets continue to be heavily influenced by the currency markets and technical analysis of the EUR/USD is far more predictive of the equities market than the actual equity market charts. This skew from the foreign exchange markets is making it difficult to read the equities markets based on traditional behavior. Globalization is making it a challenge for investors to specialize in one market and ignore all the others. The more intertwined the world becomes, the more diverse successful investors will need to be.
Right now we are at the upper end of the trading range, and if we keep the recent pattern of staying within in this 40 point ascending channel, we will see a sell-off to the 1340 level. But this will be the 5th swing of this pattern and it is getting a bit obvious and the market hates being obvious. And we can see that as we are holding up near the high of the trading range for the second day in a row. Past reversals happened fairly quick, so this is a departure already from the previous pattern. If we do in fact have a lot of swing traders shorting the market here, but the market is not going lower, that could indicate a move higher since the bullish demand is offsetting the swing-traders selling.
As always the market can head higher or it can head lower. Brilliant insight, I know, but the market is at a turning point. Right now the market is setting up for a move higher. Between all the existing bearishness and holding at the upper end of the range indicate the market is ready for another leg higher.
But there is still very real risk lower since we have so much air under us from the recent rally and being near a 52-week high. But the market has proven that it is willing to rally in the absence of horrible news. This means barring a major shock to the system, the market will hold up. But if we do hit a downdraft, be prepared to pull the ripcord quickly because the down-leg has room to run.
Based on what I see, trade the long side, but proceed with caution and be ready to run for cover.
Some leading stocks are doing really well over the last few weeks as the weight of the market has been lifted off their shoulders. But do be careful because the higher they rise, the harder they fall if the market gets sucked into a correction. Limiting any new buy to no more than 5% past the proper buy-point and that will greatly reduce the risk of getting shaken out in a normal pullback.
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.