Stocks ran up at the open on encouraging developments out of Europe, rising to the increasingly important 1565, but quickly lost steam and slid nearly 20-points by late morning. Volume was again below average and continues the recent pattern of restrained trade.
Today’s selloff was reminiscent of a market disappointed by bad news, not on the receiving end of good news. We had a Cyprus resolution and over the weekend and many predicted all-time highs were a done deal. After the first few minutes of trade, it looked like they were right, but then buying completely dried up and stocks tumbled. The news will try to explain it as this or that, but the truth is we simply ran out of new buyers.
So far Cyprus is setting up a sell the news trade. We didn’t get a short-squeeze or momentum buying on the heels of early strength and encouraging news. The market simply stalled and rolled over. This is a big flag for bulls. The market bounced countless times over the last three-months, each rebound consuming a chunk of available buyers. After a certain point, no matter how great the news, the market will top when it runs out of buyers I can’t say for certain this is what happened, but it seems more likely than not.
There is a lot of risk in this market. Without a doubt we could continue higher, but before placing a trade we have to understand the risk/reward. The market might have another 25-points of upside here, clearing all-time highs at 1576, but we could also be on the verge of a very typical, normal, and healthy 5 to 10% dip. Typically we will see three 5% dips and one 10% pullback in any given year. (20% dips are less common, occurring once every 3.5 years on average) Even if this is a garden variety 5% dip, that is 75-points. Making trades with 75-point risk for 25-points profit will send a trader to the poor house pretty quick.
No matter what the signals say, we are still within 1% of the highs and the up-trend remains in tact. Predicting anything but a continuation is going against the trend and is often the low-probability trade. Picking tops is risky, and not many people do it well. But there is a difference between picking a top and taking the chips off the table. It is very aggressive to short this market, but taking profits after such a nice run is extremely conservative and is what successful traders do with worthwhile profits. We are in this to make money and the only way we can do that is selling our winners.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. 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 manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, 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 young children.