Stocks pulled back in early trade and are under 1570. This level was recent resistance, which is supposed to become support following a sustainable breakout. Given the strong gains last week, a pullback this week is expected. The question is if this weakness is buyable or an early warning to get out.
The rally turns five-months old tomorrow. We’ve seen a few dips along the way, but they are getting smaller and smaller as dip buying becomes the norm. Early in the rally many were predicting a crash around every corner. Traders were afraid of the market and sold ahead of the inevitable Fiscal Cliff meltdown. When most sell before an event, they take the pressure off of the actual event and we often bounce when the news is less bad than feared. Fast forward five-months and traders are climbing over each other to buy every dip and their enthusiastic buying prevents any real weakness from developing. We transitioned from a market people were afraid of to one they cannot get enough of. If markets rally in the face of fear and decline on the back of complacency, it seems like we are close to a turning point.
Sentiment is a fuzzy thing and it doesn’t give hard buy and sell signals, it simply indicates probabilities. Is the market more likely to continue here or is pullback in the near future? As much as people look for the magic bullet in the market, the red-light/green-light indicator, there is no such thing. Everything in the market is fuzzy. If this were easy, everyone would be rich. We will never be able to predict the tip, but we can weight the probabilities of a continuation versus a pullback given the shift in sentiment.
Stocks are testing support at 1570. This is a perfect level for dip buyers to rush in and support the rally. If a person believes in a continuation, this is where they need to suck it up and buy the weakness. But buying the dip seems obvious and is becoming a tired trade. Dip buyers only have so much money and eventually there is a dip they no longer have the money to buy. That is the dip that doesn’t bounce. I was a bit premature in getting out of this market, but that doesn’t make the core analysis invalid. I still am reluctant to own this market and expect wider selling before the rally will refresh and resume.
Traders love buying the dip and we need to look for that same trade here. After the fear driven selling abates we need to reclaim and 1570 to prove buyers still believe in this market. Falling back into and getting stuck in the previous trading range is not encouraging for such a young breakout. The next obvious level for support is 1540 and the 50-dma. Hold this level and the dip buying bandwagon continues. If we break this level, watch out below.
Bull and bear alike need to watch 1570 and 1540. Move and hold above, the rally still has legs; break under and this is the long predicted pullback.
AAPL is struggling with $420 again and a break under the recent low of $419 could set off a wave of stop-loss selling ahead of earnings. But the more selling that takes place ahead of earnings, the less downside there will be after earnings.
Plan your trade; trade your plan
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.