Stocks sliced through 1680 and fell to the 50dma before finding support. Since the start of the year every dip to the 50dma was a buying opportunity. Is the market giving us another gift, or is this a preview of bigger things to come? It largely depends on if we assume the sideway summer trade continues or if this is the start of a new directional move.
It is late in the earnings cycle, but poor outlooks from CSCO, WMT, and M stoked fears about economic slowing. Add in upbeat weekly employment numbers that threaten QE and we have the perfect recipe for selling. At least that is what the financial press wants us to believe.
While today’s 1.5% decline is dramatic, anyone paying attention expected it as we crashed through all the stop-losses littered under obvious support at 1680. No matter the reason, many disciplined traders hit the sell button when the market crossed their stops. Once that wave of autopilot selling ran its course, we saw further weakness as fearful and emotional holders bailed out. Currently the slide is pausing at the 50dma as some traders buy the dip and nervous holders wait to see if support will hold. The new level everyone is watching is the 50dma and this creates an all new tranche of stop-losses clustered under this level.
Two days ago the media claimed we bounced on some Fed member’s bullish comments, yet today we tank on renewed Tapering fears. Really?!?!? The only way these claimed events are moving markets is if they cause traders to change their mind. Markets only move when people buy and sell, and people only buy and sell when they change their outlook. Did Tuesday’s Fed comments turn Tapering bears into QE bulls? Did today’s strong weekly employment numbers turn QE bulls into Tapering bears? Of course not, traders are far more stubborn than that! We all come to the markets with beliefs and biases. One headline here or there is not going to change anyone’s mind on popular issues, and thus it is not moving the market.
But that only applies to hotly discussed issues where people already made up their minds. Things are completely different when it comes to new, unexpected headlines. Weak outlooks from WMT, M, and CSCO caught some investors off guard. We saw cracks in the retail and economic story earlier in earnings, but most wrote this off as company specific stories. That is harder to do when the weakness is confirmed by industry leading companies. Those disappointments caused some traders to reevaluate their outlook and lightening up on portions of their portfolio. That is the true seed of this selloff.
While QE and Tapering is ancient history in a forward-looking market, we always need to pay close attention to new and unexpected developments. Right now some traders are starting to worry about economic strength and we need to see if this concern spreads and leads to further selling.
Buy the dip or sell the weakness? That is the million dollar question. Any disciplined bull is long out of the market as we crashed through their stop-losses, while many bears used this weakness to add to their short positions. All good trades, but where we go from here largely depends on if this is more of the same, or the start of something different.
Until further notice all dips are buying opportunities and we have to give the benefit of the doubt to the trend. Trends continue countless times but only reverse once. It doesn’t take a mathematician to figure out the high probability trade is sticking with the trend, but knowing what will happen and trading it successfully are two totally different things.
Even if the market eventually bounces, would could still see more near-term weakness. Catching falling knives is always a dangerous hobby and we need to wait to see how traders respond to these levels before stepping back in. As for shorts, there is a good chance the 50dma will provide support like it has every other time this year, but expect another leg down if we dip under this widely followed technical level and trigger another wave of stop-loss selling.
More likely than not we are still stuck in the summer sideways chop and the better trade for bears is locking in recent profits. If we slip under the 50dma we can press our shorts, but there is nothing more frustrating than watching a bounce gobble up all our profits. As for the bull, there is no reason to catch the falling knife. Wait for support to build at the 50dma. That likely means holding this level for another three days. It is better to be a little late than a lot early.
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.