Stocks set new 5-year highs, but how much longer can this rally keep it up? How are you going to trade AAPL’s earnings next week? Are there other ways trade this than just buying ahead of the announcement?
The S&P500 broke out to 5-year highs this week and printed levels we haven’t seen since 2007. Volume for the week was average as most traders returned from the holiday break.
The market is 65-points above the 10-week moving average and 90-points above the 40-week moving average. (similar, but slightly different from the 50dma and 200dma) While it is not unusual to trade this high above these moving averages, it makes it less likely we will go significantly higher before the MA’s have time to catch up. There are two ways the market closes the gap, one is dipping back to the moving averages, the other is trading sideways and letting them catch up. The 10-week moving average is turning up quickly and the 40-week is edging higher as well so we might have to wait too long before resuming the uptrend.
What a difference a week makes. Last week’s negative headlines disappeared and all of a sudden the world is a much better place. This is a bit of an exaggeration, but the market’s attention has moved away from pessimistic worries and is focusing on upbeat data that justify the recent strength. This is the typical tail wagging the dog that goes on in the financial press. Journalists look to see what the market is doing and then dig to find plausible reasons to explain the move. If the market goes up, they report positive developments. If the market heads lower, they highlight the negative. I don’t blame them for this, they are journalism majors and just doing their job, but as traders we have to see through the noise and figure out what is really driving the market.
We came from an extreme oversold condition following the election and no matter what the news was (impending Fiscal Cliff showdown), we were bound to rally because after all the sellers sold, supply dried up and there was nowhere to go but up. And here we are, 140 points higher and no one can claim the market is still oversold.
So where do we go from here? The economy is slowly improving, recent earnings have been decent, and politicians are making progress on the Debt Ceiling, but that is what we already know and how traders justified buying this rally. To get the market heading even higher we need even more. Either we get better than expected fundamental data or we need these fence-sitters to jump in and start buying. Without these catalysts, the market will probably trade sideways and let the moving averages catch up. And this is not a bad outcome either.
Sentiment has improved dramatically in recent weeks and the market isn’t paying nearly as much attention to negative headlines. The Debt Ceiling is a page three-story as the teflon rally breeds complacency. I have little doubt the market can keep heading higher next week as we find new shorts to squeeze, but I’m not in the business of picking tops. I want to make worthwhile a profit and then move on to the next trade.
To clarify, this position is only intended for the more active traders who try to time the market’s regular fluctuations. Longer viewed holders should keep holding, but expect some near term volatility before the market continues rallying. While many of you hold for longer periods of time, understanding what the market is doing in the near-term helps manage the anxiety when the market goes through a normal and healthy dip.
The market can continue climbing from here. The distance above moving averages is still not at extreme levels and we have room to go. There are shorts still hanging on and pessimists to be converted. This could give us one more push higher, but what’s another 20-points gain on a 140-point rally? If a trader got in early enough, it isn’t worth risking existing profits for a few more dollars.
And don’t get me wrong, I’m not predicting a crash or a sizable pullback, just step back after two big steps forward. I swing-trade the market and try to take advantage of these smaller market moves. Depending on market action, next week I could jump back in if I like what I see, but this is my trading strategy and time horizon. You need to follow what you are most comfortable with.
AAPL had an exciting week as the stock broke recent support at $500 and plunged to $484 before finding support. Most of the selling was from a high concentration of automatic stop-losses placed under the widely followed $500 level. But as soon as these autopilot orders were triggered, the market found a bottom because most of the holders who bought during recent weakness are willing to hold through some volatility. They are value investors taking a longer view on the stock and were not going to let a $15 dip change their entire investment thesis.
AAPL’s earnings are coming up next week and will mark a significant turning point for the stock. Bears have leaned into the stock recently and the burden of proof falls on them. The stock sold off in anticipation of slowing growth and shrinking margins and that has been the lead weight dragging the stock down. If it turns out the concerns were overblown, expect this weight to be cut free and the stock to pop higher. But there are no guarantees in the market, especially when dealing with such a polarizing stock. The safer play would be to trade the stock after earnings. If earnings are bad, the stock will be oversold before value investors step in and prop it up. If it beats, the stock will surge higher over coming days and weeks. In either case, the stock would be buyable after earnings and you avoid the risk of holding through earnings. The one circumstance I would not buy after earnings is if the stock traded flat. Without an oversold dip to buy or a strong rally to jump on, I’d stay out and look for something better to trade.
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.