Stocks are quietly churning sideways following yesterday’s impressive gains and record closes.
After such a strong run, it is unreasonable to expect the rate of gains to continue indefinitely. While momentum can carry us higher, at some point the market needs to consolidate recent gains before it resuming the rally. This might be as simple as trading sideways for a few days, or alternately a more dramatic pullback to support.
Weak hands bailed on Tapering fears and bears piled on the shorts in what looked like the widely anticipated QE selloff. As dramatic as the plunge felt, selling exhausted itself quickly and we rebounded on tight supply. All those aggressive bears dreaming of mountains of profits quickly found themselves on the wrong side of the market. Their pain was the markets gain as they were forced to pay premium prices on the surge higher driven by their desperate buying and holders’ reluctance to part with their shares.
Now that most shorts are safely out of the market, we need to figure out who is the next incremental buyer. Value investors and dip-buyers don’t buy all-time highs, so we can cross them off the list. There is the momentum crowd, but many of these guys are already in the market. Recent sellers are kicking themselves for being so impulsive and selling at the exact wrong moment, but the human ego is full of stubbornness and pride, meaning it is hard for these traders to pivot this quickly. At this moment, there are few buyers left to keep this surge going.
But buying is only half of the equation. If no one is selling, it doesn’t take much demand to prop up prices. Confident holders propelled this Teflon market higher all year and they could easily do it again. Nothing boosts holder’s confidence like seeing their accounts swell. Those that held through recent weakness and volatility were rewarded for their patience and this reinforces the resolve to keep holding no matter what. While some call this complacency, often it works because it keeps supply tight and that is supportive of prices.
The wildcard is recent dip buyers. Do they keep holding, or cash in for quick profits? If their profit taking overwhelms the limited supply of new buyers, prices will decline and that weakness will violate stops, causing other short-term traders to hit the sell button. That continues until we fall to a level where value investors can no longer resist and scoop up discounted shares by the truckload, effectively putting a floor under the market.
While no one knows what the market will do next, we can watch to see how it behaves and that will give us insight into which force is taking control and what it means for the next move.
Today’s sideways trade allows the market to digest recent gains. Holding these levels for a few more days in spite of all the profit taking and shorting all-time highs demonstrates the market’s strength and the next move is likely higher. But while the next move might be higher, any investment decision must weigh the risk/reward of every trade. Not only do we need to consider the probability of a successful outcome, we must also weigh the potential upside compared to how much risk we are taking. Given how strong the recent move was, it is hard to rationally expect the market to keep going at this rate for another 100-points.
While we can keep going higher, this feels like a good place to take profits and wait for the next trade. Holding these levels for a few more days gives us the green light to jump back in.
The market is a handful of points from making all-time intraday highs, which leads to another wave of short covering and breakout buying. Recent volatility put Tapering fears in the rearview mirror and the market is already looking forward to what comes next. Continued improvement in corporate earnings and economic indicators will keep this market marching higher. While the rate of recent gains is unsustainable, we can should buy continued strength and support at these levels and profit from the grind higher. The recent volatility cleared the deck, leaving a more stable and confident crop of holders, making a continuation far more likely than a correction.
After such impressive gains prudent traders are either locking in gains or moving up their trailing stops. Thursday’s low of 1665 or previous resistance at 1655 are both acceptable levels for a trailing stops depending on a trader’s outlook and tolerance for sitting through a pullback.
An aggressive short could use a violation of today’s or yesterday’s intraday lows with a stop above today’s highs. Trading sideways at these levels for a few more days shows the market is digesting recent gains and poised to resume the uptrend. Support through Tuesday is an invitation to buy back in.
AAPL‘s attempted rebound is taking the day off as the stock pulls back to the mid-$420s. This is normal and expected behavior and we shouldn’t read too much into it….yet. Continue watching how the stock responds to the 50dma to identify the next trade. Buy a break above and short a retreat from.
AMZN continues its surge higher on the back of shorts who insist it is grossly overvalued. While they might eventually be proven right, the stock is scorching premature bears and anyone else standing the way. Some people need to be right and they will continue losing money on their shorts, but for the rest of trying to make money, these stubborn bears are giving it away to anyone willing to take the other side. Reality might set in one of these days, but that is what stops are for.
Reread the above paragraph, except replace AMZN with TSLA, NFLX, and LNKD. Between the broad market and these high flyers, it looks like it is bear season the way these guys are getting killed.
Too often traders forget what is too high usually keeps going higher and what is too cheap usually keeps getting cheaper.
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.