PM: Is this the obvious top?

By Jani Ziedins | End of Day Analysis

May 22
S&P500 daily at end of day

S&P500 daily at end of day

PM Update

MARKET BEHAVIOR
One of the most interesting days in quite some time.  We made new highs following Bernanke’s remarks to Congress, but came crashing down following the release of the latest Fed minutes.  Volume was well above average and the highest since April’s dip to the 50dma.

MARKET SENTIMENT
Did we learn anything new today?  Bernanke and the Fed minutes confirmed easy money would continue, but not last forever.  Did this really surprise everyone enough to justify a 2% intraday reversal???  This was not the first time Fed members discussed ending monetary easing, but nervous traders were looking for an excuse to dump and short shares as modest selling swelled into a stampede.

TRADING OPPORTUNITIES
Expected Outcome:
We came a long way from April’s test of the 50dma and pullbacks are part of every advance.  Will this be a one-day dip before finding support?  Will we bounce off of 1600?  Or is this the end of good times and we are on the verge of a bear market?

Bear markets happen when reality is worse than expected, but this rally is based on reality being better than expected.  There is a fair amount of bearishness already priced in so don’t expect a major crash any time soon.  The global economy is weak, but improving and even though we’ve seen dramatic gains, we are a long way from euphoric highs.  Most of these gains are recovering from over-bearishness and returning to normal levels.

To trigger a moderate correction, we need a new and unexpected risk.  The Fed has always discussed ending monetary easing, so major selling on what is know and widely expected is unlikely.  Selling can always beget selling, but that simply presents us with another buying opportunity.  Someone else’s loss is our gain.

Alternate Outcome:
Every bear begins with one down day and this could be that day.  We will assume the rally remains intact until proven otherwise, but it is prudent to trade defensively after such a strong rally.

Trading Plan:
No matter which way this market breaks, expect a near-term bounce.  Maybe it will happen at 1650 or 1600, but this market will bounce.  The bigger question is if we rebound to new highs, or the bounce fizzles and we continue lower.  Cautious traders can sell proactively.  Optimistic traders can hold as long as their trailing stops don’t get triggered.  We have no idea how far this weakness will go, so the easy solution is to take our profits and wait for the next trade.  It is possible for a nimble day or swing-trader to snag some short profits with a stop above recent highs, but be prepared for a near-term bounce and take worthwhile profits.

Plan your trade; trade your plan

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About the Author

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.