The rebound continues. Friday’s post-holiday session finally closed above the 50dma and we added to those gains today. The market is 80-points above the Fed-selloff lows and only needs another 15-points to complete the roundtrip. Will this point act as overhead resistance, or clear the way for a move higher? We will know the answer soon enough.
Buy the rebound or sell the strength, that is the question. People still don’t trust this market and fear the end of QE, but the market’s rebound shows it is far less concerned with these issues. We don’t want to get hung up on what the market should do. As traders the only thing that matters is what it will do, and to find those answers we need to understand what other people think and how they are positioned.
The recent Taper induced selloff was driven by fears of QE ending and what it means for the market. Anyone who believes the market is only rising because of QE will obviously conclude that without QE, the market will collapse. This was the justification behind much of the selling a couple of weeks ago and once we reach the point of maximum pain, selling begets more selling as previously confident holders start doubting their position and bailout before the losses get worse. But at some point the selling climaxes and reverses when the market runs out of sellers. That happened at the June 24th 1560 low.
If we look at how people traded this event, we see most of the traders fearing the Taper used this weakness as an excuse to sell. The people who bought the dip are opportunistic traders unafraid of a little weakness. Exchanging weak holders afraid of Tapering and replacing them with confident traders that are not worried about the Taper fundamentally changes the dynamics in the market. This shows how widely expected events become priced in ahead of time. As we hear more tapering talk, the market will largely ignore it because most holders no longer care.
I’m not saying the volatility is behind us, just that the recent flush makes further selling on the same news less likely, and the market’s recent strength supports that argument. Remember, we don’t trade what the market should do, but what it will do. Often those are very different things.
The market reclaimed the 50dma after the recent selloff, demonstrating continued strength. As much as people don’t trust this market, it keeps heading higher and the opportunistic trader is taking advantage of it. Contrarian trading isn’t going against the trend, it is going against the crowd. When everyone fears Tapering, economic weakness, and market pullbacks, that creates a buying opportunity.
Rallies bounce until they don’t, but this market is trading a new trend of lower highs and lower lows until we break 1655. If this downtrend persists, we are part of a grinding correction lower. While everyone fears the plunge, it is the slow slide that does the most damage as it erodes one and two percent at a time when no one is paying attention. The best way to defend against this complacency is using hard stops to get us out even when we are not concerned.
We broke the 50dma on Friday and any disciplined short should already be out of the market . Swing traders bought the breakout last week and are riding this strength higher with a stop under 1630. Bulls still holding should move their trailing stops up to 1625. Expect volatility to continue and look to take profits somewhere near 1670, or alternately use a trailing stop to protect recent gains. As we already know, holding too long will give back all these profits in the next swing. It is impossible to predict the exact turning points in choppy markets, so we need to be satisfied with what we get. This is the wrong place to be complacent or greedy. Remember, most people reacting to these swings are losing money so any positive return this summer is something to be proud of.
Everything seems to be working except AAPL. TSLA, AMZN, GOOG, NFLX, and LNKD are all near 52-week highs. Stocks that are too-high keep going higher and stocks that are too-cheap keep getting cheaper. Most often the smart trade is going against our gut. AAPL at $440 was the buy of the decade while TSLA at $100 was the most obvious short in years. And both trades have been exactly wrong. Contrarian trading is going against the crowd and we must acknowledge most of the time we think exactly like the crowd. If we see value, so does everyone else. When we see outrageous prices, the crowd sees it too. My best trades have all been the hardest to make while the easy ones lead to some of my biggest mistakes. Fight the crowd, not the trend.
Plan your trade; trade your plan
Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, 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 children.