AM: Weakness persists

S&P500 daily @ 1:10 EST

The market is running out of buyers prices are softening.  Some will blame this or that, but the truth is a change supply and demand is the driver behind this weakness.  Look for a potential sawtooth selloff to at least the 200dma.

MARKET BEHAVIOR

Stocks tried to stage a rally in the first hour of trade, but quickly fizzled and we are currently down 0.3%.  Yesterday’s reversal had a large intraday range, but it happened on low volume.  From this we can infer it wasn’t a wave of selling that hit the market, but a lack of buying.  This further reinforces the notion this rally is running out of buyers.  If prices continue declining, we will naturally expect volume to pick up.  It will be this burst of volume on downside that signals the end of the pullback as the last surge of the sellers rush for the exits.  At that point selling dries up and we head higher due to a lack of supply.  The market is one a giant pendulum that swings back and forth.    It seems we are starting to swing back the other way.

There are a lot of people who claim it is foolish to time the markets.  What they really mean to say is most people, pros and amateurs alike, cannot time the market.  But that is simply because they are looking at the wrong clues.  The market is pretty straight forward if you understand the dynamics that cause prices to rise and fall.  Namely the emotions and positioning of other traders.

MARKET SENTIMENT

Over the last couple weeks the market’s rebound seduced many traders into thinking the Fiscal Cliff didn’t matter any more.  Anyone who was shouting doom and gloom was humbled by the recent rally and it encouraged anyone who expect the Fiscal Cliff to be resolved to jump in head first.  But the market doesn’t like being easy or predictable, so just as everyone thinks they have it figured out, the market throws a wrench into the works to keep everyone off-balance.

The biggest question we need answered is if this is the start of a real pullback, or just the last short-squeeze.  It is super easy to figure out what the market will do next, the challenge is knowing when it will do it.  Timing is where all the money is made.  Without a doubt the market will pullback because it always does, what we need to figure out is when it will happen.

TRADING OPPORTUNITIES

Breaking the 50dma yesterday and squeezing out the last of the bears really puts the odds in favor of this being the real pullback.  But don’t mistake favorable odds with certainty.  There are no guarantees in the market and the chances of this being the real pullback are about 2/3 to 1/3.  So while it makes the pullback more likely than not, out of three similar setups, one will continue higher.  But as a trader that is okay.  The goal isn’t to always be right, but to make more money when we are right than we lose when we are wrong.  We use risk management techniques like limiting losses and letting winners ride.  We also look for setups that put the probabilities in our favor.  Combining these techniques vastly improves the chances we will be successful, but there are no guarantees in this game.

I think this is the real pullback, but there is a smaller probability there could be last short-squeeze before this rally leg is done.  Most likely we will see a sawtooth lower as  bottom-pickers get sucked in prematurely on the way down.  The rule of three works pretty well in these situations.  This is where we get two or three head-fakes before the real reversal happens.  There is a lot of psychology behind why this happens, but just know that every short-squeeze or false bottom brings us one step closer to the one that actually sticks.  Ignore the first couple, but get ready to trade the 3rd or 4th.  We had several short squeezes over the last couple weeks and that is why I am more confident in this attempted pullback.  And on the other side we’ll see a few failed rally attempts before the real one can succeed.

INDIVIDUAL STOCKS

AAPL outperformed yesterday and is getting whacked today.  There are opinions abound about AAPL from it being the first trillion-dollar company to it falling 70%.  And you know what, both could be right.  AAPL’s rally could still have legs if international sales continue exploding.  While AAPL’s products are premium priced, the number of people around the world who can afford it are growing every day.  It is highly unlikely AAPL will lead the budget handset market, but with the exploding global middle class the pie is growing so fast AAPL will do just fine focusing on the upper end of the market.  But at the same time technology companies rarely dominate for long.  Palm and Rim are recent examples of 800lb gorillas  being supplanted by a newer innovator.  Ten years from now Apple will still be a big player, but it won’t have the coolest or most innovative producer on the market.  It is fine to trade AAPL, but I wouldn’t plan on handing shares down to your heirs.  Hardware is just too volatile for any one company to stay at the top of the hill for more than a couple iterations.

Stay safe