WR: Taking a step back

Weekly Review

MARKET BEHAVIOR

This was the first negative week since the November low.  The market peaked on Wednesday after taking out the pre-election highs, but gave back all of those gains by Friday’s close.  Weekly volume was slightly under average, but we cannot read a lot into that since we are in a traditionally low-volume period between Thanks Giving and Christmas.

MARKET SENTIMENT

The market has only ended negative on 5 of the last 21 trading sessions.  That is a pretty impressive run and explains how we gained nearly 90 points.  As impressive as that run has been, every run eventually comes to an end.  Are we at the end of this run with two-consecutive down days on Thursday and Friday?  And what does the end of a run mean?  Is it just the end of the straight up phase of the rally?  Or does the end mean falling off a cliff?

If you look back at what has been done, our three-week rally is peanuts.  The most impressive rally was early this year where over an eleven week period we had just one week ending in the red.  By that yardstick we can’t even come close to claiming a three-week rally is grossly over-bought.  But if this market isn’t over bought, what is it?  Maybe it is just resting.  Maybe it had a few too many chasers as we broke above 1435 on Wednesday.  Maybe Thursday and Friday are just another bear-trap on our way higher.

As far as sentiment, bulls are more confident and comfortable than they’ve been in months.  A bounce off of a low will do that as it reassures holders that this was the right decision.    But it would be a huge stretch to call this market complacent.  Bullish headlines are few and far between as even non-investors cannot escape all the Fiscal Cliff chatter.  The most bullish headline of the week was a report that our politicians were fighting a little less.  Talk about a half-full reason to rally.  Further, many market participants expect us to fly off the Fiscal Cliff.  Of course politicians on both sides saying they are willing to take the plunge doesn’t help foster an optimistic environment.

Many times I’ve said markets rally in the face of pessimism and decline on the back of complacency.  This is boiler plate contrarian investing.  People trade their opinions and anyone expecting doom-and-gloom is already out of the market.  If a person is 100% in cash, the only thing they can do is buy stocks.  If the majority of market participants are pessimistic over all the economic risks in front of us, then they are already mostly in cash and the only thing they can do is buy this market.  This is exactly why the Obama selloff bottomed and rallied so strongly.  When the only option left to most people is buying, the market can’t help but rally no matter what the headlines are.

TRADING OPPORTUNTIES

Some of the commentary in this post conflicts with what I’ve written about in daily posts, but this is where timeframe makes a big difference.  Daily posts look at what will happen over the next few days.  These weekly posts look at what will happen over the next few weeks.  And in cases like this, I expect some near-term weakness, but remain long-term bullish.  That is why it is important to take a step back and look at the big picture.  The market tries to seduce and trick us with its misleading daily fluctuations, but it is far harder for the market manipulate weekly charts.  It is always better to trade with trend.  This is sailing with the wind at your back and it takes very little effort to succeed.  Compare this to the trader fighting the larger trend and he has to work very hard tacking into the wind.  Trading the counter-trend moves can be done successfully, but it is exhausting and leaves little room for error.  When contemplating shorting this market here, a person should ask themselves what is the bigger trend?  If the trend is lower, grab on and make easy money.  But if the trend is higher, shorting a modest dip is an aggressive and risky play.  It can be done successfully, but it is far more difficult.

INDIVIDUAL STOCKS

AAPL’s been giving people heartburn again. An analyst downgrade sent AAPL to its lowest close in nearly a year.  It is hard to find someone who is jumping up and down, screaming what a buy AAPL is at these levels.  The stock is 28% off its 52-wk high and that is scaring away a lot of potential buyers.  But that is one of the most odd things about the stock market, people only want to buy expensive merchandise.  Put something on sale and they turn their nose up at it because it is too ‘risky’.  But the truth is AAPL was a far more risky at $700 when everyone was excited to own it than it is here at $500.  Why do people fight each other to pay $700 for a stock and won’t touch the same stock with a ten-foot pole at $500?  It all comes down to how the mind works and what people are looking to get out of the markets.

The human mind is great at seeing patterns (even when they don’t exist) and a trend is an easily recognizable pattern.  Stock investors are in this to make money and they want to buy something that will go up in price.  Obviously a stock making all-time highs has been going up and the natural assumption is this pattern will continue.  At $700, buyers see this obvious pattern and expect prices to continue going up.  And when you flip that around, after a 28% decline people won’t get near a stock because the pattern tells them it will continue going lower.  But to be successful in the markets we have to fight our natural instinct and trade with reason and logic, not emotion and intuition.  Maybe AAPL has more downside left, but without a doubt it is far less risky to own AAPL at $500 than it was at $700.

ET CETERA

I want to thank everyone for all the positive feedback regarding this blog.  I enjoy writing these posts and am happy to hear people are finding them useful.  And for those tweeting and re-tweeting these posts, I am extremely flattered and appreciate you helping spread the word.  I don’t make any money from this blog, but sharing ideas with fellow traders has been invaluable in improving my trading and I’m glad to be able to give back to the community.

Stay safe