Head fakes and sideways trade

By Jani Ziedins | Intraday Analysis

Oct 27

S&P500 daily at end of day

Another day of head fakes and sideways trade.  Expect the market to reveal its hand next week, but the question is which way will it take us?

MARKET BEHAVIOR

Another day of sideways trade.  Early on it looked like the market wanted to breakdown, but that turned into a head fake as it quickly bounced back to 1410.  This is the fourth day we’ve traded around this level and obviously this can only last so long before the market reveals its next move.

There are four possible outcomes.  The two obvious ones are breakout or breakdown, but what about the other two?  The market is often devious and will mislead us before revealing its true intentions, so a fake breakout before turning lower, or a feigned plunge before rebounding hard.  Sometimes the market plays straight poker and others it bluffs; that is what makes it so hard to for traders get an edge.  Right now the trend is lower and more often than not the trend continues.  We need to plan for further weakness until the market proves otherwise.

MARKET SENTIMENT

The market is holding 1410, at least that is what it wants us to think.  This stability is frustrating bears and seducing bulls.  It’s saying, “Come on in, the water’s fine.”  But the thing to remember is the easy trade is often the wrong trade.  If the market feels like it is firming up and tempting us to venture in, it is probably a trap.

Frequently the hard trade is the right trade.  We need to ask ourselves what is harder to do right here, hold or sell?  Has this pullback put fear back into the market?  How scary can a 4% decline really be?  Is that enough to chase out weak hands and clear the way for a move higher?  Or does the market need to drive a spike through the heart of hopeful bulls still hanging on by their fingertips?  Fear fuels rallies and right now there is not nearly enough fear in the markets to power a meaningful rally.

TRADING OPPORTUNITIES

This week has been a day-trader’s paradise with the strong directional intra-day moves, but the market made very little progress for either bulls or bears as three of the last four days closed within one point of each other.  Every move by one side has been matched with an equal response by the other.  Where does that leave us?  When all else is equal, stick with the trend.  We need a high-volume capitulation point to shakeout weak investors to set the stage for the rebound.

We’re within shouting distance of 1400 and that represents both psychological and technical support.  No doubt a dip under this key level will trigger all sorts of autopilot stop-loss selling and aggressive shorting by bears.  But that selling will be the end of the move, not the start of something bigger.  Once the stop-losses are executed and the shorts sold, the selling and supply of available shares will dry up in a hurry and there will be nowhere for the market to go but up.  The market will bounce somewhere between 1400 and the 200dma so if you are short, don’t get greedy and be ready to harvest your profits before they disappear.

And of course the above is just my best guess based on sentiment, historical patterns, and probabilities.  Nothing is certain in the markets and it is foolish to trade that way.  The market could bounce next week and push up to 1450 crushing any and all shorts.  It could also plunge through the 200dma on panic selling when Obama is reelected.  While either of these moves might cause me to lose some money, I don’t mind because these new moves create more opportunity.  I trade extremes in sentiment and my best trades are going against big moves.  This stuff in the middle of the range is the hardest to anticipate and has the lowest probabilities.  I might get this move wrong, but a wrong trade here just leads to another opportunity to profit.   I’ll never make all the money and I’m fine with that.

Stay safe

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About the Author

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.