Stocks closed positive and the recent support is indicative of a continuation. AAPL sent waves through the market as it broke $500, but is it setting up a double-bottom?
The market closed above 1470 for the fourth consecutive day and it was the third time early selling failed to gain traction and bounced back in the afternoon. The market is one point from setting a new 52-week high, but it continues struggling with 1474. Volume was below average, but higher than Monday.
Bears cannot recruit new sellers to join them in bringing down the market, but at the same time bulls cannot break through the 52-week high either. No doubt we will see a resolution to this stalemate in the next couple days.
I see a fundamental difference between bears inability to recruit sellers versus bulls struggling to entice buyers. It is always easier to get people to sell, especially when headlines are negative and everyone is yelling overbought. So why are bears having such a hard time shaking anyone loose? Most likely it is because holders don’t want to sell and are comfortable holding through some near-term weakness. These longer-viewed investors are keeping supply off the market and preventing any selloff from building momentum.
On the other side, bulls are dealing with reluctant buyers. There are plenty of people standing around watching, but they hang back, unsure of these new levels. But unlike bears who have failed to trigger follow-on selling after multiple market dips, bulls have not tried to get their bandwagon rolling yet. Things could get exciting if the market finally breaks 1475 as shorts are squeezed and momentum buyers jump onboard. But bulls must make their move before gravity takes over and the market drifts back to the lower end of the trading range.
Holders continued holding in the face of early weakness. Their resolve to see this thing through keeps supply out of the market and this confidence supports an upside resolution to this consolidation. How big that move will be is anyone’s guess. A huge surge higher might not be sustainable, but a more modest one could let this market continue higher for a bit longer.
Bulls only have so long to make their move before they lose their credibility and the market will at least retest support at 1450. When all else is equal, gravity takes over and prices slip because there are many reasons people sell, but only one reason to buy.
This is a tale of two cities. While the broad market is holding up nicely, AAPL had a major violation of support. With so many stop-losses concentrated under $500, it was too rich of a target for the market to pass up. But now the technical driven selling came and went, the question is where do we go from here.
In the comments of last night’s post I wrote about the psychology of a double bottom and what makes it work. I’ll copy an excerpt here for those that missed it.
“We are seeing the psychology that makes double-bottoms such a common reversal pattern. The first rebound sucks in the eager buy-the-dip crowd, but because nothing in the market is easy, they get humiliated by the next pullback. A key part of the double bottom is the second bottom undercuts the first because this flushes out the last of the hopeful holders and sets the stage for a rebound.”
“There are no guarantees in the market, we are simply playing a game of probabilities. AAPL’s recent strength brought in bottom-pickers and they are running for cover these last two days. The rest of the ownership is value buyers who bought the stock in the face of recent declines and are willing to sit through some weakness. We could easily see further weakness, but there is a limited number of bottom-pickers remaining in the stock and once they are gone, supply will dry up and the stock will bounce.”
But while I don’t see a reason to bail on AAPL after today’s selling, this is a good time to talk about risk management. First and foremost, if you are uncomfortable and uncertain, sell and reevaluate. It is always easier to think clearly when you are outside the market looking in. And you can always buy back in once you formulate a new plan of attack.
Another useful strategy is to limit your risk in any one trade to 3%. Don’t mistake this with a 3% position or a 3% stop-loss. That 3% limit is the amount of your account value you can lose on each trade. If you have a $100k account, that means you can risk $3k on a single trade no matter how much you have invested. If you have $50k in AAPL then you can take a 6% loss, but if you only have $10k invested in AAPL, then you can sit through a 30% pullback.
The reason for the 3% loss limit is it lets you live to fight another day. With this you have to be wrong more than 20 times in a row before your account value will be cut in half. Between the 3% rule and your calculated stop-loss target, you can figure out how large of a position you can take. The tighter the stop-loss, the larger position you can take.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.