PM: More low volume selling

PM Update

MARKET BEHAVIOR

Markets declined on light volume.  We are just a hair above the 50dma and clearly under previous resistance at 1420.  Volatility is modest as the last few days of weakness failed to trigger a large wave of selling.  Is the market growing complacent after a 90-point, straight up rally?

MARKET BEHAVIOR

Everyone knows where the market came from, but very few can tell you where it is going.  The clues are there, we just need to learn how to spot and interpret them.

Supply and demand moves stocks in  four different ways; 1) over-abundance of willing buyers, 2) over-abundance of willing sellers, 3) lack of willing buyers, and 4) lack of willing sellers.  Today’s decline on low volume was a victim of insufficient willing buyers.  The low volume selling over the last couple days reveals not many people are concerned about this selloff as they continue to holding.  Is this the result of complacency taking over?

Typically it takes large volume selling to set the stage for a rebound.  This is because on the way down, weak holders sell to more confident value investors who are willing to sit through some volatility.  After a high volume purge, you end up with fewer weak holders and more confident investors.  That is the tipping point that tightens supply and turns a decline around.  (Looking at AAPL’s chart shows some of this high-volume selling taking place and is part of the reason I think there is hope for the stock.)

We had several of these high-volume down-days in early November and that was part of what turned the market around on Nov 16th.   Since then we have seen a lot of buying push the market to new post-election highs, much of it on higher volume.  But like on the way down, high volume buying on the way up also shows the makeup of the market is evolving as conservative investors sell to the more bold who are happy to chase the market higher.  These new owners are the impulsive investors that follow the crowd, but they are also the first to panic when the market turns against them.  And so here we are, two days into a modest correction with very few people worried about the slide so far.  This might suggest there is more selling ahead.

Many discount these ideas because they think we are stuck in a news driven market and next week’s price moves are simply an unpredictable result of what the headlines are.  I see their point, but I also know news does not drive markets, only supply and demand can do that.  The news might be random, but the market’s reaction to it is not, and that is the source of our advantage.  If we know what traders think and how they are positioned, we can figure out how they will respond to different pieces of news.

TRADING OPPORTUNITIES

So where are we?  Great question.  First I want to remind everyone I do not have a crystal ball and cannot see the future.  There are no guarantees in the market, but in the market we don’t need to be right all the time to make money.  Like card counting, we look for different clues to move the odds ever so slightly in our favor and over time we will come out ahead.

It seems like the market is full of traders expecting a Fiscal Cliff resolution, or alternately assume going off the Fiscal Cliff is not as bad as most fear.  These are the traders who were comfortable buying stocks during the dip to 1350, but now that the market has rallied 90 points from the November low, we are running short of new confident buyers willing to step in front of the Fiscal Cliff.  And that is why prices have declined on light volume.

I think there is some further weakness ahead based on the above, but we are still in a bull market and counter-trend trades don’t last long.  We will probably bounce somewhere around 1400.  Maybe it is 1405, or maybe it is 1390.  Look for the high volume purge that shakes out most of the weak holders and replaces them with confident and patient buyers willing to buy shares at a discount.

INDIVIDUAL STOCKS

AAPL was pounded today, see my AM post for more thoughts about this particular selloff, but more broadly we are getting a lot of shares changing hands here in the lower $500 range.  Opportunistic value investors are buying shares at a steep discount from fearful and emotional traders who can’t handle seeing the losses mount.  The market has run short of AAPL bulls and most everyone is bashing the stock here.  The selling might not be done yet, but more selling just creates a better base for the stock.  Seeing the stock break under $500 on the highest volume in months would be a great buying opportunity because that could be the last shake-out.  Of course there are no guarantees in the market and catching falling knives is a hazardous way to make a living.  The far more conservative approach would be to let the stock bounce from that low before buying in.

Stay safe