The breakout is dead, long live the breakout

By Jani Ziedins | Intraday Analysis

Nov 03

S&P500 daily at end of day

The breakout stumbled as the market gave up all of Thursday’s gains.  We are retesting support at 1410 and both bulls and bears are licking their wounds from the last two days of trade.  Next week’s election is setting up as a turning point for the market and we need to get ready to buy the next breakout.

MARKET BEHAVIOR

Stocks surged higher on a better than expected jobs report, but reversed within the first hour and ultimately gave back most of Thursday’s gains as well.  Stating the obvious here, but there was no follow-on buying to support Thursday’s upside breakout.  It appears Thursday was nothing more than a short-squeeze/bull-trap and no doubt it zinged a lot of traders.

Bumping our head on the 50dma and 1430 resistance is not encouraging and no doubt the last two days of bipolar trade have put a dent in bull and bear accounts alike.  On a positive note, we are still above 1410 support and we’ll see how traders respond to a test of this level on Monday.

MARKET SENTIMENT

With the election early next week, big money was unwilling to buy the breakout and is taking a wait-and-see approach.  Volume was above average, but less than Thursday’s breakout.  The somewhat muted volume shows people were not panicked and rushing for the exits en masse.  It was a lack of buying rather than a flood of selling that sent us lower.

The ironic thing about today’s failed breakout is it makes the next breakout more likely to succeed.  With so many bottom-pickers getting humiliated by all the recent head-fakes, they are losing confidence and thus less willing to buy the next dip.  What this means is the next time we see the market pop, it will be driven by more real buying from major institutions and fewer fair-weather bottom-pickers.  Why this matters is big institutions are not traders and they are far more willing to hold their positions and even add to them.  With that kind of support, an institution sponsored rally is far more likely to stick than one driven by bottom-pickers.

I don’t know when the next rally attempt will happen, but I do know there will be far fewer bottom-pickers leading the charge.  If there are fewer bottom-pickers, then by default there must be more institutional buyers, and that is the higher-probability breakout I want to jump on.

TRADING OPPORTUNITIES

We could see additional weakness on Monday as traders contemplate the outcome of Tuesday’s election.  It feels like there is still a lot of hope Romney will pull off the upset, but as we all know, hope is a poor strategy.  We need to anticipate what will happen, not what we hope will happen.  Unless the polls on Monday start showing a real advantage for Romney, the markets will begin anticipating an Obama win.  A lot of those hopeful Romney supporters might start selling due to an irrational fear of a market crash if Obama wins reelection.  The market rallied through Obama’s first-term and there is no rational reason to expect it will spontaneously fall apart under his second term.  Only a small sliver of the market holds this extreme view and the selling will dry up fairly quickly.

There is no reason to try and pick a bottom.  Let the market do its thing and wait to jump on the next solid rally attempt.  Like everything in the market, there is no guarantee the next rally attempt will work, but this is a game of probabilities.  We want to make all our trades with the wind at our back.  Most of the known bad news is already priced in the market and pessimism will climax under an Obama reelection.  Once that selling runs its course, supply will dry up and there will be nowhere to go but up.  Chance favors the prepared mind.

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.

Paolo November 3, 2012

Hi, I keep on reading that bottom pickers are somewhat responsible for this lousy price action. Are they really so numerous and powerful to influence the market? I suspect that only market makers and big investors/traders can drive the price. i’m not an expert and might be totally wrong. Thanks.

    Jani Ziedins November 3, 2012

    Good question. Both of your points are correct. Only big money has the financial resources to sustain a major price move. But mutual funds have an average holding period of close to a year, meaning they don’t do a lot of trading. After they buy and are holding, they no longer influence the daily price action and are just along for the ride. It is the day-traders and high-frequency guys who turnover their portfolio multiple times a week that create the short-term chop in the markets. They are small, but they are extremely active and that significantly magnifies their influence over daily price moves. Typically moves are started by the active group, but these guys quickly run out of ammunition (money) because of their smaller size and the move can only continue if big/slow money jumps on board the move too. Thursday’s rally was lead by short-term traders trying to pick a bottom (and active bearish traders who were short getting squeezed) and it failed to stick because big-money didn’t get behind the rally. The active crowd ran out of money and that is why we quickly gave back all those gains. I hope this answered your question.

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