50dma bounce

S&P500 daily at end of day

MARKET BEHAVIOR

The S&P500 bounced off the 50dma in slightly higher volume.  It is finding buyers are these levels, but the trade seems constrained and is not in the same category as the upside pops we’ve seen recently.  Those pops were fueled by an overly bearish market getting squeezed, this time it looks more like the selling simply exhausted itself.  Did today’s support mark the reversal of the slide, or is this a temporary relief-rally before another wave of selling hits the market?

Buying at the 50dma is the obvious trade.  But does the market want to cooperate with the hopeful bulls that are holding on by their fingernails right now?  Can the market resist the temptation to flush out and humiliate all those hopeful traders?  We’ll have our answer in a few days.

MARKET SENTIMENT

There are three buyers of today’s bounce.  Shorts locking in profits.  Swing-traders and bottom-pickers jumping on what they think is the reversal.  And finally value investors dipping their toe in the water after prices have declined to an attractive level.

Short-covering and bottom-picking are temporary events.  The sustainability of a rally is determined by the conviction of value investors stepping up at these levels.  To this point value investors sat on their hands as the market declined due a lack of buying.  Have we come down far enough to get them interested again?

Without a high-volume shakeup penetrating key support levels and triggering a wave of stop-loss selling, where are the new buyers going to come from?  Any rally without a capitulation bottom is built on a foundation of sand because it lacks that large pool of available buyers ready to chase the market.  Further, many of the weak holders are underwater and hoping a rebound will let them get out of at breakeven.  That will create selling pressure on any climb back to new highs.  I’m a bull here, but I’d feel better with a gut-wrenching whoosh lower that cleans the slate.

We can’t ignore presidential politics when discussing market sentiment.  Romney is surging in the polls after a strong showing in recent debates.  No doubt unexpected Romney strength could cause the market to rally into the election.  But if this is the case, the trade becomes buy the rumor, sell the news.  The markets will pop on a surprise Romney win, but more often than not the market makes as many people look foolish as it can.  If everyone is convinced a Romney win will make stocks takeoff, the market will confuse and humiliate everyone by heading lower instead.

TRADING OPPORTUNITIES

I think more weakness is needed before we can rebound decisively.  We could see more upside following today’s bounce, but the market will likely return to the 50dma before too long.  The quickest way to resume the rally is to have that flush out event now and then move on.

At this point I’d suggest keeping what you’ve got.  If you are trying to hold your stocks through the correction, keep holding.  If you took profits and are looking for the next buying opportunity, hold back for a bit longer.  It is too late to sell and too early to buy, so just sit tight.

Stay safe