Weakness continues: opportunity or warning?

S&P500 daily @ 2:24 EDT

MARKET SENTIMENT

Markets opened lower, as they’ve done three of the last four days.  In the previous two weak opens, we pulled out of the dive and closed close to even.  Will the third time be the charm?

Market participants continue their pessimism over all the negatives in front of us, yet the market continues holding near its high.  Bears are shouting from every high place this market is over valued and they are short.  Big money managers are expressing concern.  The media is hyping up all the bad news.  Heck, even I can’t figure out why the market is holding up at these highs given everyone’s concerns.  But we profit from price moves, not people’s opinion, so that is what we must focus on.  The market wants to go up and we must respect that.

We’ve had a recent bout of weakness, but everyone must recognize the market can’t go straight up and make it easy for everyone to rake in money.  The market is notorious for making us think we are wrong before eventually proving us right.  The challenge becomes knowing when to stick to our guns and when to admit defeat.  The recent price action is shaking out a lot of weak bulls and encouraging anxious bears to take the plunge on the short side.  This weakness is expected and healthy price action for a bull rally, but the fear is this same price action could also be the market rolling over and the perceived support is nothing more than naive bulls jumping in and buying the dip.

The question we have to ask is which side are the naive traders on, the long side or the short side?  Naive traders always follow the crowd.  They are the me-too traders who always show up late to the party and are stuck holding the bag.  All their money flows directly into the pockets of savvy traders.  The key to finding the naive trader is figuring out which side the crowd is on.

If the majority of this market was excited about this breakout and talking about how much higher it would go, then I would be selling this market.  In March, I ruffled a lot of feathers when I told people the market was setting up for a pullback.  See my March 13th post for my analysis of the market back then.  Everyone was bullish and expecting big bull market gains.  That is why I got nervous and sold out of the market close to the peak.  Fast forward to today and at those exact same price levels, raging bulls are few and far between.  Most everyone is cautious and reluctant to buy this market, as demonstrated by the ultra-low volume.  Same price level, 180 degree different attitude toward the markets.  In March the sentiment was set up for a sell-off, today the sentiment is set up for a continuation.

But as I was getting to earlier, the market can’t go straight up, so this whipsaw move we are seeing is designed to shake out the weak hands and temp bears to put their heads in the guillotine.  What will determine how far this minor dip lasts is how quickly it can shake out all the weak bulls and tempt the ambitious bears.  We have to clear the deck of this dead weight before we can continue higher.  Maybe we do that holding above 1400, or maybe we need to drop under 1400 to trigger a final wave of automatic selling that will only happen when everyone becomes convinced the market is breaking down.

Being a bull in these markets is a lonely proposition, but the more of an outcast I am, the more likely it is I’m on the right side of this trade.

MARKET BEHAVIOR

Market continues to trade tight and in low volume.  Opening down half a percent in early trade is a big move for this market, but still peanuts from where we came from.  The increased range will give day traders a little more to work with, but still a far cry of this summer’s multiple percent per day moves.  But for the bull case, this is encouraging because historically rallies tend to be low volatility and low volume as most investors are comfortable holding and are not bailing en mass at every headline that crosses the news wire.

TRADING OPPORTUNITIES

The market is showing it wants to retest 1400.  Trading within in a few S&P points of 1400 it seems inevitable given market makers’ financial incentives to push us into a region that will trigger a wave of trading.  But even a dip under 1400 won’t break the rally.  No doubt the ultra-short term traders can profit from these counter-trend dips, but any longer time frame needs to respect the uptrend we have in place.  Too often the easy trade is the wrong trade, and if this market feels too extended and prone to pullback, that is exactly what makes it a good buy.  We are biologically wired by evolution to feel more comfortable in crowds.  In trading we feel more comfortable trading with the crowd, yet supply and demand and other pricing dynamics make following the crowd a losing proposition.  Our instincts are wired to survive in the wild, not succeed on Wall Street.  The time will come when we need to fear the market, but that will be when it feels safe.

CRUS daily @ 2:24 EDT

INDIVIDUAL STOCKS

AAPL in the red today, but only giving up a fraction of yesterday’s gains.  The uncertainty in today’s markets is driving big money managers into the perceived safety of mega-cap, blue chip stocks.  Following that same theme, HD is showing strength and is holding up better than the market in this mini-correction.  Speculative growth names like FRAN and KORS are also doing well with surging relative strength lines.  For breakouts, HAIN is surging 18% today and SNPS gaped 5%.  CRUS is impressively adding to its late July breakout in high volume today, but remember CRUS is extended from a valid buy point.  In spite of the headlines, there is a lot of good stocks showing strong relative strength to choose from.

There is a lot of encouraging price action in leading stocks, defying the bearish sentiment seen in the rest of the markets.  We continue to be in a confirmed uptrend and often the best buying opportunities are the scariest.  By the time it feels safe, all the best profit opportunities will be gone.

Stay safe