Markets gaped lower at the open. Is this the sell-off everyone is expecting? Sure feels like it. We’re near 52-week highs, the headlines are ominous, and everyone is reluctant to own this market. To be honest, I completely appreciate the bear case here and am tempted to side with them, but the one thing that holds me back is the abundance of bearish sentiment in the markets. Fundamental and technical traders are underweight this market because of all the above reasons, and they are good reasons, but when we start analyzing sentiment and supply and demand, the picture starts looking different.
All things being equal, the sentiment skew is set up for a move higher because most often the crowd is wrong. The crowd already made their trades and are simply along for the ride because only new buying and selling moves market prices. If the bears are already underweight, out of, or short this market, they have done their best to move the markets and seeing as how we are stuck near 52-week highs, they didn’t move it very far. But the noteworthy thing is all these bears are available and able buyers if the market forces them to change their minds. This potential upside fuel is quite bullish because these supply and demand dynamics results in the crowd most often being wrong.
The above works under normal circumstances, but there are rare occasions where stocks can keep falling even after everyone is already bearish and that is when there is a complete lack of buyers. Stocks are always traded from one person to another, meaning someone always owns stocks. From these owners there is always an available supply of potential sellers. But on the flip-side no one ever has to buy stocks. A good example of this is housing in Detroit. Someone owns the real estate up there, but even when some houses are listed for less than $1,000, they still can’t be sold. Even if you gave it away free it could sit on the market simply because no one wants it at any price. Same thing can happen with stocks. But this is the extreme case of panicked trading where value investors would rather sit on their hands than buy something at attractive prices. We saw this phenomena in 1987, 2008 and most recently in 2010’s flash crash. The thing to remember is these are very rare, emotionally charged environments where buyers are paralyzed by fear, and in most instances they make for great buying opportunities once the dust settles.
I don’t expect this extreme case to play out and based on conventional market sentiment and contrarian views, I’m cautiously sticking with my bullish views. Given market dynamics of supply and demand, I expect an upside resolution to this consolidation even if we see some near term volatility first. Remember, supply and demand always trumps opinion.
Markets dipped under 1400 again and actually undercut Friday’s low of 1398. But while the dip is noteworthy, we continue trading within 2% of a 52-week high, so hard to say the market is struggling and breaking down. This is still a bull rally until the bears can prove otherwise, and minor tests of resistance levels don’t cut it. Of note, the 50dma is ramping up and closing the gap between itself and our current levels. Many market participants view the 50dma as a buying opportunity and it often provides support for bull markets. The closer the 50dam comes to the current market, the less downside there is before reaching this safety net. It wouldn’t be unheard of for a bull market to dip down to the 50dma, but isn’t necessary as markets can often levitate above the 50dma for months at a time without a check-back.
Volume continues coming in far under average. Neither the bears nor the bulls are leaning into this market in a meaningful way and it is a stand-off between the two waiting to see which side will blink first. No doubt we could breakout of this trading range in either direction and our trading plan needs to take this binary outcome into account. I think the probability of an upside resolution is slightly greater than a breakdown, but in the markets nothing is certain. Stay open-minded to what the market is telling you even if you don’t want to hear what it has to say.
TFM is adding to yesterday’s losses, but pausing at the 50dma. With such volatility, there are really only two possible outcomes, crash on through the 50 or bounce off it. Just like with the indexes, many big money managers don’t like chasing high-flying stocks and will instead wait for a pullback to the 50dma. When a stock finds good support at the 50dma, it often means institutional investors are accumulating shares at this level and a rebound is likely. A high volume bounce off the 50dma would be a buying opportunity, but obviously a plunge under should be avoided. While it is no fun for anyone who holds TFM in their portfolio, reversals like this are a part of trading and why we maintain defensive sell rules. Stick to your rules and you’ll survive to fight another day. And lets not forget, sell rules are not just for selling, but can also help keep you from getting shaken out in a 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.