Stocks settled down following last Wednesday’s massive reversal. While we’ve witnessed intraday volatility, closes have all been within 6-points of where the selloff dumped us. It certainly doesn’t feel like it, but the market has been stuck in a trading range between 1635 and 1675 for over two-weeks.
Stability so quickly following an alarming selloff is a big red flag for bears. Everyone knows the market came too far, too fast and is grossly overbought, but why didn’t we continue imploding following the obvious top last? Bears will mumble something about irrational exuberance, gullible dip-buyers, complacency, or some other bearish buzzword, but the truth is far simpler than that, the plunge abruptly ended because we ran out of sellers.
When traders expect something, they trade ahead of it. If the crowd anticipates a pullback, they take profits and short the market, they don’t stick around and wait for floor to fall out from underneath them. When people share a similar outlook and sell proactively, they take supply out of the market, leaving fewer to actually sell the breakdown.
Why this stability is a warning flag for bears is it shows there are no sellers left. The few sellers left leading up to Wednesday’s reversal all bailed out in the subsequent down days Everyone who continued holding through the obvious top or confidently bought the dip is not going to flinch at a little more weakness. Their willingness to hold steady keeps supply tight and there is nowhere for the market to go but up.
There is nothing wrong with making an aggressive trade, but we must pull the plug when it doesn’t work as expected. There was a strong case for a wider correction, but when it didn’t happen as expected, we have to reevaluate our assumptions. It is okay to be wrong, it is fatal to stay wrong.
The market had the perfect setup to selloff, yet here we stand practically flat for the fifth day in a row. This strength and stability proves the market is not willing to give everyone the selloff they are waiting and hoping for. The rate of recent gains cannot continue indefinitely so consolidation and sideways trade here is normal and expected.
The best way to know the market is ready to breakdown is to see it breakdown. Rallies always end and this one is no different. A series of lower-highs and violating support shows buying is drying up and the inevitable pullback is taking hold.
Everyone wants to trade breakouts and breakdowns, but the truth is the most frequent move is sideways. Recent support shows the market doesn’t want to breakdown and continued gains at the previous pace is unsustainable. Until the market proves it is ready for the next leg higher or lower, assume we are in a trading range and buy weakness and sell strength. Near-term levels to watch and trade are 1635 and 1675. More significant levels signaling a potential continuation or breakdown are 1600 and 1700.
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.