Indexes opened lower, but in bull markets stocks often open weak and finish strong. That has been a common theme over the last month and we’ll see if it continues today. The sell-off only declined half a percent in early trade, which is fairly trivial when compared to the volatility we lived through over the last few years. If -0.5% is a bad day, I can live with that. Not to say we can’t have larger sell-offs ahead of us, but it seems this market doesn’t want to sell-off more than that. We trade the market we are given and this is the market we have.
There are a lot of comments floating around that the low ultra low VIX is indicating a lack of fear and over confidence by bulls, something often seen before a correction. And while the VIX is extremely low, I don’t see the requisite overconfidence in the majority of market participants. In fact, I think most are expecting a pullback and not fully committed to this rally, indicating the opposite of overconfidence.
Remember, the VIX is a derivative of a derivative and each time you make an indicator from another indicator, key information is lost. Math nerds know every time you take a derivative, you lose the constant and that is why when you try to reverse engineer the original equation (integrate), you have to add back in an unknown constant. The only thing a low VIX actually tells us is option premiums are cheap. The unknown is why options are cheap and we cannot determine that by looking at the VIX. Options could be cheap because of overconfidence, but they could also be cheap because of low historic volatility. Looking back at how the market’s character has changed from wide and loose to ultra-tight where intra-day ranges are under one percent, it is little wonder option premiums have come in a lot. And lets not forget, bull rallies are accompanied by low volatility. A low VIX doesn’t have to mean a reversal is imminent, it could be telling us that this bull rally still has gas in the tank.
No doubt the volatility will return and we will have a correction, but in the markets timing is everything. Bears will be right……..eventually, but the overabundance of bears needs to work itself off before we will have the correction everyone is waiting for. For the time being, I expect the market will head higher and the VIX will go lower much to the dismay of all the bears.
The tight trade and bullish trend continues. Don’t let yourself be stuck trading this summer’s patterns because we have clearly moved beyond that pattern. The market is trading tight with an upward bias and it will probably continue this way for a bit longer. Only after the majority of bears and reluctant longs have bought into this rally will it be ready to top. Remember the way to make money in the markets is to recognize trends early and then prepare to change gears once the trend has become obvious to everyone.
Continue holding your longs. The market is marching higher and pullbacks in individual names are trivial to non-existent. It’s been a while since it has been this easy to hold stocks. But lets not get greedy. Set profit targets of 20-25% for most stocks and start looking for the exit when you find yourself daydreaming about what you are going to buy with all your stock market profits.
AAPL is the big story of the day, making fresh all-time highs. The chart looks scary and is triggering a fear of heights in many traders, even hardcore AAPL bulls. While the gut might be screaming too high, most often the gut is wrong in the markets. Our brains are wired to protects us from lions and tigers, not stock crashes. In fact the markets often move exactly opposite of our instinctive impulses. Who hasn’t bought exactly when they should have sold? Who can say they never been shaken out and watched the stock shoot higher without them? Or worked up the confidence to buy only to top tick the move and see the stock come rushing down as if the market knew you were buying and was making it personal?
The truth is the market is agnostic and it could care less about any of us and is not intentionally out to hurt us. It moves are entirely based on the emotions of the crowd. The crowd is made up of individuals that react to feelings of fear, greed, hope, and despair. We are all wired the same and most often react the same. This is great attribute when trying to form a bond with other members of the tribe because our chances of survival are far greater when part of a group as opposed to being an outcast trying to defend yourself from all the scary predators in the wild. But these same herd instincts are going to get you killed in the financial markets.
Supply and demand dynamics work in such a way that the crowd is most often wrong. This creates an inverse self-fulfilling prophecy because when crowd believes in something, most of the buying has already occurred and there is little buying left to keep pushing prices higher. This is why crashes start when everyone is the most excited about a stock.
But when looking at the current AAPL trade, there is a healthy dose of skepticism in the market. To see this, check out the various posts on StockTwits under AAPL’s feed. There seems to be a lot of reluctance to buy this breakout, meaning there is still a lot of money available to bid up the price. What we need to watch for is when the crowd becomes overconfident AAPL will continue higher, only then should you develop a fear of heights. The best I can tell we are not there yet and there is still upside left in this name.
Of course it is obvious AAPL has come a long way and is widely held, so the best way to trade AAPL trade might be to ride this momentum higher and then cut out after a respectable 20% gain from the breakout. At least that is the way I would play the name. We could see a buy the rumor, sell the news into the iPhone 5 announcement in a few weeks, especially if the new phone doesn’t have some radical must have feature that stimulates a lot of upgrades.
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.