PM: Embrace or shun this market?

PM Update

Markets closed modestly lower, is this a healthy pause or the start of the end?  AAPL took off today, but does this move have legs?

MARKET BEHAVIOR

The market gave back some of Thursday’s breakout and failed to set a new all-time closing high on Friday.  Instead of just 2-points away, we are now 4-points from the record.  Volume was off the chart, largely because of futures and option expiration (quadruple witching).

MARKET SENTIMENT

Friday’s gigantic volume showed a fundamental shift in many traders’ risk profiles as both speculative and hedging options expired and future contracts were settled.  Many traders who were previously indifferent to downside volatility because they had put protection are now flying without a safety net.  This fact alone will add volatility to the market because these traders are now more sensitive to weakness.

Maybe it is a coincidence, but the last time we saw this level of turnover was Sept 14th, the market’s exact top-tic before the Fall selloff. Taken by itself, this is a trivial piece of information, but combining it with other factors sets off all kinds of warning flags.  This this rally is 4-months old.  We are approaching the end of the quarter. We have the left shoulder and head of a H&S pattern.  People are afraid to short this market as seen in the lack of short-squeezes on blowout employment and new highs.  All the experts are predicting another 25 to 50-points in this rally before pulling back.  Volume is tapering off because holders are holding for larger gains (greed) and buying is drying up (running out of buyers).  The market shrugs off bad news (sequester and negative GDP).  And half a dozen other reasons I can’t remember right now.

As comfortable as people feel, this is the riskiest the market has been since the November lows.  The paradox of the market is people are most afraid during the safest period following a dip and aggressive in the riskiest period following a large run-up.   I have no idea what the market will do next week, but I fear this market more than I have in many months.  My paranoia might be premature, but I’m okay with that.

TRADING OPPORTUNITIES

Expected Outcome:
It is hard to be constructive on this market.  Today was the second close above 1560 and another couple closes above this level on Monday and Tuesday means we are likely to make a run at all time highs above 1575.  But as traders we have to ask ourselves if 15-points of upside is worth 100-points of risk.  As far as we’ve come, there are two people in the market right now.  The greedy holding out for more and the late buying just before the top.  Is that the company we want to keep?  Or should we be looking for an exit?

As individual investors we only have one advantage in this game.  Big money has the resources, experience, and inside contacts we cannot compete with.  The one thing these guys cannot touch is the nimbleness of our size.  We are  in and out of trades in seconds where it takes big money weeks to build and exit positions.  The best use of our size advantage is pulling out when the clouds are building and the odds are against us.  If we sit through market turmoil, we give up the only advantage we have in this game.

Alternate Outcome:
The dip to the 50dma last month flushed out many weak holders, clearing the way a continuation higher.  There  easily could be another 100-points of upside left in this rally.  No one knows what the market will do and all we can do is trade probabilities.  Given all the clues we have, is the market more likely to top in the near future or continue higher?  Obviously I think the high probability outcome is topping, but because of our nimbleness we are not committed to one trade.  We can easily change our minds when new information invalidates our previous thesis.  The safest trade here is to lock in profits, but for those that want to see if there is more left in this rally, move your trailing stop-up to 1545/1550.

INDIVIDUAL STOCKS

AAPL had a phenomenal day and regained levels we haven’t seen in since February.  But one day doesn’t make a trend and we need to see AAPL continue proving itself before it becomes a worthy buy candidate.  The first minor technical level to reclaim is $455, a minor peak last month on the way lower.  This would be a modest victory as the stock notches its first higher-high since the selloff began, but the real level to watch is $485.

Without a fundamental catalyst reigniting AAPL’s growth, it is unlikely the stock will trade above $485.  Dividend and buyback are nice, but they don’t change the growth story, only blowout earnings or a revolutionary new product will do that.  Can AAPL reinvent its product line again, or is it just another Sony, AOL, PALM, NOK, or BBRY? (all the most innovative companies of their day)

Stay safe