Selloff takes a breather

S&P500 daily at end of day

The market ends flat, but many traders and pundits expect further weakness, a sign that can be interpreted as much of the selling has already occurred.    We might have lower-lows in our future, but look for a bounce here as late shorts get squeezed out of the market.  Near-term volatility will make this a swing-trader’s market.

MARKET BEHAVIOR

Market finished mostly flat on Friday after some ups and downs, but given the price action of the previous two days, this is a significant victory.   Volume was higher than average, but less than either Wednesday or Thursday.  For the time being, panic driven selling has abated.  This is a good thing because selling can trigger even more selling in a snowball effect.  The pause today gives traders the weekend to regroup and reevaluate their portfolio.  After some time away from the markets, investor’s nerves might calm down and we might see more rational trade next week.

MARKET SENTIMENT

Given the plunge over the last couple days, almost all the weak hands have been shaken out.  But the thing to remember is this pessimism is creating the fuel that will power the next rally.

People who are excited about the market are fully invested and can’t move the market any higher.  A pessimist is out of the market and the only thing he can do is buy stocks and push the market higher.  This is why contrarian investing works.  Optimists are powerless to move a rally higher, only pessimists can do that.  Too much optimism and a rally stalls; too much pessimism and things are primed to take off.  Learn to fear confidence and embrace pessimism.

From where we stand, it is hard to imagine the fear over headlines getting worse.  If you talk to any investor, the only question is whether Obama, the Fiscal Cliff, or Europe will crush the stock market first.  That kind of widespread pessimism, confusion, and fear among retail investors creates golden opportunities.  If these guys want to give away their money, I have no qualms taking it.

TRADING OPPORTUNITIES

The market looks very buyable here.  The panic driven selloff paused and gave investors a chance to regroup.  An avalanche of selling is a dangerous thing to jump in front of, but after the dust settles there are deals to be found.  If the market continues to find support here, look to wade in.  No reason to plunge in all at once.  Buy a little, let that show a profit, and then buy a little more.  If the market rolls over, your portfolio risk is mitigated because you are holding a smaller position. Chalk that loss up as a cost of doing business and look for the next entry point.

If we do rally next week, it will be interesting to see what kind of rally we get.  Often we can see a powerful surge higher as the shorts get blown out of the water.  These pops rarely last long before collapsing, so if we see big gains, get ready to lock in profits and wait to buy the pullback.  If we churn sideways and grind higher slowly, you can continue holding for an extended period of time.

We could see some near-term volatility as the market tries to figure out which way it wants to go and most likely we will be in a buy-the-dip, sell-the-rally mode through the end of the year.  If a savvy investor takes profits early and often over the near-term, it really doesn’t matter if the market heads higher or rolls over, you’ll win either way by trading the swings.  The only advantage individual investors have in this game is our nimbleness; don’t fail to take advantage of it.

Stay safe

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