Stocks closed at all-time highs following Bernanke’s dovish comments Thursday evening. While dramatic, the rebound from the 1560 lows has been on light volume. Today’s volume was the swiftest of the month, yet it failed to register above average levels.
The two-faces of Ben Bernanke. His comments a few weeks ago sent the market into a wild tailspin. Today people are jumping for joy following his comments on Thursday evening. One could accuse him of market manipulation and some are doing just that, but the comical thing is Ben stuck to the same exact script the entire time. Full steam ahead on bond purchases, but mindful of signals to start withdrawing monetary stimulus. A month ago people panicked and sold all their positions on those headlines. This month its been nothing but buy, buy, buy. No wonder people call the market irrational!
As traders, it is our job to make sense of this mess. Any regular reader of this blog knows why the market rebounded so swiftly. The weak sold in the panic driven selloff, confident buyers unfazed by a little volatility and uncertainty snapped up those discounted shares, eventually we ran out of emotional sellers, supply dried up, we had nowhere to go but higher, and here we are, completing a 200-point round trip over just a few weeks.
That was then and this is now. It is fun to talk about what happened, but money is made by knowing what comes next. It is often helpful to think of the market like a spring. Sometimes it is all coiled up, ready to pop. Others it is overextended, poised to snap back. Applying that analogy to this market, it is hard to claim we are a coiled spring after a 130-point move in less than a month. That certainly diminishes the potential of further explosive upside from here. Without a doubt momentum could continue, but the risk/reward changes dramatically with every leg higher. At this point we might have 25-points of upside left versus 50-points of air underneath us. That is obviously a less than ideal trade.
The reason further upside is more limited is most of the shorts already covered as we crossed nearly every technical stop-loss they could use. While this market rose on the backs of confident holders who kept supply tight, the fuel was provided by shorts scrambling to cover and forced to pay premium prices to end their misery. Now that most of them are out of the market, this rally needs to find new buyers, a challenge since most traders have a fear of heights and are reluctant to chase breakouts.
While the momentum is clearly higher, there comes a point in every rally where prudent holding for worthwhile gains crosses the line into unrealistic optimism and greed. I have no idea if we are there yet, but after such a strong run, it is hard not to take some profits and wait for the next trade. We are in this to make money and the only way to do that is selling our winners. Today was a painful day for shorts as the gap open chased off many, but the stubborn stuck around hoping for the gap to close and were pinched by the afternoon rally to all-time closing highs. By all measures we are running out of shorts to keep pushing us higher and this rally will stall without a new crop of buyers. Obviously value investors don’t buy all-time highs and anyone who sold two-weeks ago is still too shell-shocked and/or stubborn to reverse course so quickly.
Clearly momentum is higher, but every trader needs a point that is good enough. Anyone who sells into strength will always sell too early, but that is the way most successful traders do it and maybe they know something the average trader doesn’t. The great thing about selling early is the market always gives us a chance to buy back in. All we need to do is keep our eyes, and minds, open.
Many holders are nervous as we rally this quickly and push to new highs, leading them to take profits ahead of the inevitable pullback. But the fact this market held up so well in the face of profit-taking and shorts doubling down, shows there is still plenty of life left in this rally. We have not seen that high volume surge higher that traditionally signals exhaustion, so we must continue watching for strength and entry opportunities from this unshakable rally.
We should assume this market remains range bound until it proves otherwise. Only breaking to new highs and holding them will convince us otherwise. Since we are in the upper end of the trading range, look to sell strength and lock-in recent gains. We always get out too early on the way up, but no one can consistently top-tic the market and it is a fool’s errand to try. The best we can do is take worthwhile profits and look for the next trade.
How the market responds on Friday will tell us a lot about the next trade. Stalling and failing to hold recent gains shows the market is struggling to find new buyers. This creates a shorting opportunity with profit targets back at the 50dma and 1600. Setting new highs on insatiable demand shows this rally has legs and we will buy the breakout with a tight stop under previous highs.
Friday will be an important day in testing the mood of the market and the resilience of this rebound. How it trades will set the stage for the market’s next move.
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.