AM: Markets struggling for direction

S&P500 daily @ 1:14 EST

AM Update

MARKET BEHAVIOR

Markets opened above the 50dma and almost instantly began selling off.  Could this be the last short-squeeze before pulling-back and digesting some of the recent run up?  It is still early in the day and we need to watch if the market rebounds this afternoon like it has with other recent intra-day declines.  If we fail to get that bounce, we might be seeing the market shift character and a change its near-term trend.

MARKET SENTIMENT

Everyone knows the kind of rally we’ve seen since the bottom on Nov 16th can’t keep going up indefinitely.  But what they know rationally doesn’t always connect with what they feel when looking at their trading screens.  We had several categories of traders in the recent move:

• The first were the fearful trader who sold out on the slide and is looking at this rebound with deep regret.
• Next are the fearful traders who were paralyzed during the decline and through inaction inadvertently held through the dip.  He is felling pretty good about himself right now.
• There is the opportunist who felt the selloff was overdone and bought the dip and is beating his chest with pride.  Some of these dip buyers sold for a quick profit, but many are feeling cocky and still holding for more gains (greed).
• We also have the bear contingent that have waited for this market to break wide-open and have piled on the shorts every chance they get.  They were on top of the world a couple of weeks ago, but are now bloodied and battered 4+ short-squeezes later.
• And the last group is the value investor that has a longer-view and holds through good times and bad.

Where we go from here largely depends on what the aggregate of the above groups does next.

• Prudent risk management has forced most shorts out of the market as we relentlessly marched above one key technical level after another.  At this point most of their buying is done, but this also means they have fresh resources to re-short the market if new weakness develops.
• Regretful sellers of the Obama dip are sitting on their hands afraid to act.  They are rationalizing that selling two weeks ago was right thing because the market really is going to breakdown…….eventually.  While most of these guys can’t put any additional selling pressure on the market because they are already out, they won’t support the current rally with their buying either.  Eventually they will come around and provide fuel for a future rally, but it takes time for them to regain their confidence and for fear of losing money to be replaced by fear of being left behind.
• Indecisive owners who held through the dip are likely to have flashbacks if prices start falling and they could easily get shaken out this time around.
• And the last group of value investors are cool, calm, and collected, but they are also reluctant to buy stocks after a run-up and instead prefer to let prices come back down on what they view as the inevitable pullback.

So what does all the above mean?  It means we are running out of new buyers and a fresh wave of sellers could show up if prices start pulling back.  The financial press always tries to find a fundamental reason stocks moved one way or the other, but the truth is prices only move to balance supply and demand.  Now sometimes unexpected news will affect expectations and in turn skew the balance of supply and demand, but often in  medium timeframes supply and demand will move the market by itself independent of the news around it.  For example stocks will often sell off when everyone is most optimistic on a stock because at that point everyone who wants some already has some and without any new buyers waiting in the wings, demand dries up and the price declines.  The opposite has happened here.  Fiscal Cliff talks have grown further apart over the last two weeks, but the market has rallied in the face of these negative developments.

TRADING OPPORTUNITIES

If there was a time to lock in profits, now is looking pretty good.  If the break above the 50dma doesn’t stick, this would also be a place for aggressive and experienced traders to look at shorting the market.  But if we continue holding these levels for a few days, that shows buying hasn’t climaxed and there is still upside left in this move.  If that is the case, I don’t think owning the market here makes for a good risk/reward because there is only so much higher this steep rally can go, but for shorts it would be a prudent to cut bait and wait for the next entry.

INDIVIDUAL STOCKS

AAPL is still in the green, but off of early highs like the rest of the market.  All of the above commentary applies to AAPL as a stock too.

Stay safe