PM: Is it finally time to be cautious?

PM Update

Markets recovered from early selling and set new highs, but rather than celebrate, I’m growing nervous.  AAPL is settling around $500 leading into earnings, but look for big upside and limited downside after earnings.

MARKET BEHAVIOR

The market opened weak and finished strong, this time adding a third of a percent and setting another new high.  Volume was 12% higher than average and a tad above Thursday’s breakout.

MARKET SENTIMENT

Stocks had two strong intra-day surges, one recovered early losses at mid-day and the second pushed to new highs into the close.  No doubt these strong rallies were fueled by shorts covering and day-traders buying the now routine afternoon recovery.  For weeks the market has opened weak and finished strong, to the point of being a broken record, but beware of the market’s trap.  Once you think you have things figured out, the market changes the rules.

Republicans offered a deal that would push the Debt Ceiling back three months and the market seemed to like that combined with other positive earnings related news.   After the market is clearly marching higher, predictions of a pullback have been silenced by relentless strength and repeated 52-week highs.

Rather than be lulled by the complacency taking hold in the market, the savvy trader is getting nervous.  Anyone buying the rally here is late to the party and is taking a huge risk.  The market is most dangerous when it feels the safest.  This is the invincible rally that nothing seems to phase, but that is what I am most afraid of.

TRADING OPPORTUNITIES

Expected Outcome:
I’m increasingly cautious here and anyone who has been reading these posts will detect the change in tone.  The rally into the close is what finally gave me pause.  Ideally we would have traded sideways for a bit before marking a new high, allowing us to build more of a base.  No doubt we can continue higher, but this seems like a good time to take profits and look for the next high-probability trade.  The goal isn’t to make all the money, just take the easy stuff and let the gamblers try to pick the top.

There are two ways this rally will continue, on is fast and the other is slow.  Fast is not sustainable and will reverse without warning.  The second is steady and deliberate.  The latter is what big moves are made of, but given the slow nature of  sustainable moves, there will be plenty of time to jump back onboard once the market proves itself.

Alternate Outcome:
If the expected trade is taking profits, then the alternate is doubling down.  No doubt we could see the market surge higher as more shorts get chased out of the market, but this is not a sustainable phenomena and buying will climax and reverse quickly.  Timing these moves takes the kind of precision that can only be achieved through pure luck and is not a game I want to play.

No doubt I’m getting out of the market early, but I’m okay with that.  If I’m wrong, it is a lot easier to get back in than recover lost profits from holding too long.  If we see the market pullback and find support at 1473, I’ll consider buying back in.  If the market surges higher, I’ll look for a place to short the market. If we break under 1473, I’ll also look for a short entry.

INDIVIDUAL STOCKS

AAPL dipped under $500, but recovered mot of those losses by the end of the day.  The $500 level is far less significant after all the stop-losses were triggered earlier this week.  That is why this break under $500 today was fairly uneventful.  We are a couple of days from earnings and shouldn’t expect the stock to do much before then. Both sides made their case and now we wait to see who is right.

If the stock disappoints, expect initial weakness but the stock will quickly find a floor as value and income investors snap up discounted shares.  If AAPL surprises to the upside, look for a big move on the release, but continue holding for additional gains over coming weeks as the pessimism is flushed from the stock.  Limited downside and huge upside makes for a great asymmetrical trade.  But as always, no matter how confident you are in a trade, make sure you can be wrong and still survive to trade another day.

Stay safe