AM: The Tapering rally

AM Update

MARKET BEHAVIOR
Stocks rallied following yesterday’s dip, the first red-day in nearly two-weeks.

MARKET SENTIMENT
Bernanke told Congress Tapering will begin before the end of the year and the market rallied on the news.  No doubt this positive reaction is leaving many dumbfounded because June’s plunge was predicated on fears of Tapering.  Just a few weeks ago the world was ending because of Tapering, but now it’s a good thing?

Hopefully this reaction doesn’t come as a surprise to regular readers of this blog.  Anyone afraid of Tapering sold in last month’s emotional selloff, meaning those still holding this market are not worried about tapering.  When Bernanke didn’t just hint or suggest, but full on said Tapering will happen by the end of the year, it was met with a yawn by the markets.  All the Tapering selling happened weeks ago, meaning there was little selling left for today’s announcement.  As people trade their biases and outlook, they price in those expectations.  This is the exact reason markets “sell the rumor and buy the news”.

The market only appears irrational when we don’t understand how it works.

TRADING OPPORTUNITIES
Expected Outcome:
While the market briefly violated 1675, it held support in principle.  The market is too sloppy to draw technical lines with a straight edge.  Crayons are better tools because technical levels are regions, not lines.  This makes things a little more difficult for a trader because our stops are  specific points and we are forced to pick an exact level to get out.  This is why it is usually prudent to give ourselves a little cushion under support when picking our stops.  We expose ourselves to a little more downside risk, but we reduce the chances of getting shaken out prematurely.

What is encouraging is the market briefly violated a widely watched level, but reclaimed it by the close.    The weakness invited holders to bailout, but they hold strong instead.  This strength suggests all-time highs and 1700 are easily within reach.  How much further is anyone’s guess and we need to be careful because the risk/reward changes with every point higher.

Alternate Outcome:
As tapering fears disappear, that makes me nervous.  I largely ignore the crowd’s worries because they represent buying opportunities, but as we keep eliminating one worry after another, I get nervous.  By its nature the market is a paranoid beast and it cannot go long without fixating on the next impending catastrophe.  Since the market moved past Fiscal Cliff, Sequester, Cyprus, and now Tapering, it is ready for a new obsession, one that is not priced in and will take the market by surprise.  The trend is higher in the immediate future, but keep an eye out for the real selloff everyone’s long been waiting for, but more recently started forgetting about.  It is coming.

Trading Plan:
We can own the market with a stop at 1675 and look for a move above 1700 but how much further is anyone’s guess.  The risk/reward is not very favorable, so we must be careful.  For those that locked in nice gains recently, there is no reason to force a trade.  Remember, it is easy to make money in the markets, the hard part is keeping it.

Plan your trade; trade your plan