The S&P500 briefly dipped under the 1400 level as doubters and swing traders challenged yesterday’s breakout. Given all the cynicism and how little the bears were able dent the rally demonstrates bulls are firmly in control at this point. Even though bears make up the majority, they have exhausted all their resources fighting this rally and are helpless to stop it. Little by little the bears will give up, admit defeat, and change sides. Their buying will add to the rally and the higher it goes, the more pressure there will be on the remaining bears to change sides.
No doubt there could be an unexpected headline that turns the market on its head, but with everything we know and what is expected and feared out of employment, economy, China, and Europe, the trend is clearly higher no matter how dire the world seems to the fundamentalists. We trade the market we are given and this one is inclined to go higher. And we should trade it from the long side until everyone has become bullish, at which point we cash in and go short.
Today’s price action supports yesterday’s breakout. No doubt we could see a pullback into the trading range, but it seems like the market has broken from the summers trading range and we should not see a retracement back to the lower trend line. If we do head back to the lower trend line, that would indicate this breakout has failed and we should anticipate breaking through the lower trend line and continuing materially lower.
The interesting thing to watch for is the new personality the market adopts going into the fall. With the bullishness seen in the charts, we could see a nice rally as all the bears end up chasing the market and are forced to buy every dip. Their buying of the dips will keep any pullback modest and make it easy to hold stocks.
Plan A: Buy this breakout and there are lots of high quality stocks to choose from. But be careful and don’t chase a stock that is already extended from a proper buy point. There will be some volatility as we try to hold this breakout and try for a new 52-week high. Skeptics and swing traders will shoot against the breakout and they could have some temporary success holding down the markets. Given growth stocks will react two to three times as much as the indexes, buying an extended stock could lead to a shakeout if the market pulls back. Most winning stocks won’t correct more than 5% from its proper buy-point, but if you buy the stock more than 5% from the proper buy poiont you can easily get shaken out on a very normal and healthy test of the breakout. Remember half of all breakouts test the buy point and we need to buy right so we can sit through that.
Plan B: A modest dip under 1400 is expected, but if the bears are really as weak as they seem, the market will reverse higher rather quickly. But if the slide continues deeper, we need to reevaluate our position because the bears are stronger than expected and it also shows bulls lack conviction to hold. Breaking the mid-point of the trading range will be a key benchmark to watch for.
PCLN is getting crushed today. It is one thing to have a high-flier pullback due to a downgrade or skepticism. Professional opinions are no more reliable than amateur ones when it comes to near-term price moves and often the more bearish the pros are, the more upside potential . But when a company starts reporting real slowdowns in business, that is something an investor cannot ignore. Opinion is opinion, but fact is fact. Maybe this is just a single bad quarter for PCLN and they’ll bounce back next quarter, but it could also signal a fundamental shift in growth trends and that can absolutely crush a high P/E stock whose valuation is based entirely on huge growth expectations. PCLN has had a huge run, but most of these stocks come back down to earth eventually and maybe this could be PCLN’s turn.
PCLN could sell off for a few days, but most of these sell offs don’t go straight down. They’ll sell off hard, but then rebound and look like they are recovering. It could even retake the 50dma, but if the stock really is broken, that would be a great opportunity time to place a short.
Or this could just be temporary growing pains and PCLN is forming another base that will eventually breakout to new highs in a few months. But don’t buy until you get a legitimate breakout. Bottom fishing and hoping for a recovery is not a high probability trading strategy. If growth really is slowing, that could cut the P/E and thus the price in half, meaning there could be a lot more room on the downside.
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.