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Look Ahead

I’m adding weekend posts designed to take a wider view of the markets and filter out much of the daily noise.  These Look Ahead posts will focus on what we could see in the coming week and how to respond and trade those possible outcomes.

MARKET BEHAVIOR

As we covered in the last post, the weekly charts show the recent selloff is not much more than a standard 200dma correction at this stage, far from a major selloff that some feared.  Larger selloffs and bear markets tend to grind lower so slowly that people hardly notice the small leak in their portfolio.  The last few weeks were anything but a stealth move and what goes down quickly finds a bottom quickly.  While we might not have seen the lows of this move, we certainty found an intermediate bottom and recaptured nearly all the emotion fueled Obama reelection selloff.

MARKET SENTIMENT

We are entering the holiday zone between Thanks Giving and Christmas.  Trade will be lighter than average, but with the markets up nearly 13% there will be pressure on some portfolio managers to catch up to their benchmarks by yearend.  At the same time you might see other managers that are ahead sit on their profit cushion and coast into yearend.

We regained most of the Obama selloff and the market showed once again that emotional trading is the quickest way to give away money.  Many of these traders would have been better off-putting a pile of money in their driveway and lighting it on fire.  That would have been far more efficient and spared them the emotional torment of being on the wrong side of the market.  But that trade is now ancient history, so lets focus on what is in front of us.

The market is at a decisive turning point.  The market can prove its strength and march right through the 50dma in defiance of all the headline risk domestically and internationally.  This scenario is not unreasonable given the fair amount of pessimism currently priced into the markets and the recent selloff that flushed out weak holders and replaced them with opportunistic value investors who are far more patient and willing to sit through volatility.

The next scenario is the market breaks the 50dma and passing this key level triggers autopilot breakout buying from managers who don’t want to be left behind and stop-loss buying from bears managing their risk.  Key technical levels attract clusters of buy and sell orders, often creating a self-fulfilling prophecy, at least temporarily.  The big test will be watching for follow on buying after the short-squeeze.  If buyers fail to show up at the higher valuations, demand will dry up and we’ll reverse fairly quickly.

And the last scenario is where buying dries up before we even have a chance to touch all the buy orders sitting above the 50dma.  We could simply run out of buyers after all of last weeks buying, or the rhetoric in Washington reaches such a level that buyers get nervous and step away.

TRADING OPPORTUNITIES

I’ll take these in reverse order.  The selloff scenario is pretty straightforward.  If the market sells off and fails to bounce back immediately like we’ve seen in recent weeks, expect it to continue lower and retest the 200dma, likely breaking through it before finding footing.

A short squeeze above the 50dma will fail quickly and present an even better opportunity to short the market.  Wait a few days and let the market prove itself before buying the breakout.

And lastly, a sustainable break above the 50dma will hold above this level for several days, at which point we can assume real buying is propping up prices at these levels and we can tentatively venture in on the long side.

Honestly I would be surprised if we didn’t see some volatility before this consolidation is resolved.  But this is a good thing; volatility is how traders make their money.  Don’t complain about the markets indecisiveness and irrationality, profit from it.

Take a wait and see approach Monday morning and watch for which of the three above scenarios starts playing out.  Maybe it will happen Monday morning, or maybe we’ll trade sideways for a few days.  But there will be a resolution to this test of the 50dma and we need to be ready to trade it proactively.

INDIVIDUAL STOCKS

Expect AAPL to struggle with the 200dma unless the broad market decisively breaks through the 50dma.  A double bottom is still on the table, or alternately the stock could just churn sideways.  At this point it needs a catalyst to regain the $700 level.  Maybe that is a great quarterly report, a highly compelling AppleTV, or some other new and must have device.  The holiday season will be important for AAPL and it could blow away estimates since most of its products were refreshed last month and that will lead to larger than normal upgrade wave this quarter.

Stay safe