Stocks were modestly lower before the Fed minutes injected some life into the market and we broke through June 18th’s intermediate high. The market is on a terror, closing higher the last four days and eight of the last ten. Clearly things are not going the way bears were predicting two-weeks ago.
It is amazing how quickly a rising market calms nerves. Over the last two-weeks Tapering fears gave way to Tapering acceptance and many are ready to move on to the next thing. While the media is busy dissecting the nuance of today’s minutes, anyone trading last week’s fears is missing the boat. Free markets are the most efficient information discounting mechanism ever conceived. Without a doubt Tapering could rear its head again at some point, but the previous bout of uncertainty, fear, and emotional selling is behind us.
This is a good time to look back at the last half-year of market predictions and expectations. We started the year under the cloud of the Fiscal Cliff and another four-years of Obama’s leadership. Political opinions aside, the market’s knee-jerk reaction following the election was a swift selloff. Then there was the Fiscal Cliff, Sequester, weak employment, lethargic GDP, Obamacare, Cyprus, Europe, inflation, China, Japan, Tapering, rising interest rates, and countless other major headlines I already forgot. All of these fundamental events and expectations were supposed to spell doom for the markets. When we throw in “too-far, too-fast”, this was the most obvious short of the last decade, so what happened?
The reason we could safely ignore all the above fear mongering is everyone was talking about it. Anything on the crowd’s mind is already priced in. While this is easy to say, it is far harder to accept. When we know things are bad and about to get worse, we naturally become convinced it will send the market lower. If fundamental data directly moved market prices, this is the way it would work and making money in the market would be easy. But fundamentals and technicals don’t move markets, only buying and selling does that. This simple idea trips up more traders than anything else and is why many accuse the markets of being irrational. When the marked doesn’t do what we think it should, clearly we cannot be wrong, so the market must be wrong. But the truth is the market behaves perfectly rationally once we understand what makes it move.
When the crowd expects something in the future, it trades it today. The Fiscal Cliff is a very bad thing, so rather than stick around and get our head cut off, lets sell ahead of time. When everyone in the crowd does this, all the selling for an expected event happens early and there is no selling left for actual event. This is how the crowd’s ideas and opinions become priced in and why we can ignore what everyone is talking about. When the headlines are overwhelmingly bearish we can safely buy the market because everyone already sold, there are few sellers left, and the market is poised to bounce on tight supply. And that is the story of the first half of 2013.
The market cannot go up every day and after such a strong run, we should not be surprised to encounter a couple of red days. As long as the selling is contained and we stay above our stops, we can continue holding the rebound. The most nimble and conservative traders can lock in recent gains, but it all comes down to timeframe and targets. Selling here is not wrong and neither is holding for further upside.
The recent strength might be nothing more than habitual dip buying reinforced by months and months of buyable dips. Every rally ends on a dip that doesn’t bounce and this one will be no different. Failing to hold the recent break above the 50dma shows we are running out of buyers and will likely retest the lows at 1560.
The market is above support and advancing nicely, but we cannot expect every day to close higher. Don’t over analyze individual moves and look for how the market responds to widely followed levels. Staying above the 50dma is supportive for a continued rebound. Keep stops under this level and hold for a push into the upper end of the summer’s trading range. If we close under support, it shows buyers are losing strength and we can short the market with a stop above the 50dma and a price target near recent lows. Expect trade to remain choppy and take profits early and often because they will likely be gone days later.
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.