AM: Is the rally over?

AM Update

MARKET BEHAVIOR
Stocks remain a hair under the 50dma, but so far have not triggered a second wave of stop-loss selling after violating this widely followed moving average.  The summer season is coming to a close and expect more meaningful portfolio adjustments by the big guys in coming months as they prepare for year-end.  Many times this means directional trade as opposed to this summer’s sideways moves.

MARKET SENTIMENT
Aside from a couple of brief excursions, the market remained between 1600 and 1700 since May.  Currently we are in the middle of this range as traders continue arguing between buying the dip and shorting the impending collapse.  The market price is the exact balance point between bulls and bears and as of today, that puts us exactly in the middle of the summer’s trading range.  By itself this is neither bullish nor bearish because both sides have equally valid arguments, so we have to peel back the layers to uncover more meaningful insights.

We know selloffs are typically swift as selling begets more selling.  Halting the slide and holding this level into Tuesday will largely end last week’s selloff and it will take a new catalyst to reignite it.  Maybe that is new earnings data to further pile on WMT, M, and CSCO’s disappointments.  Maybe it is more technical selling as we slip under the next tranche of stop-losses.  And of course both of those could set off another round of emotional selling, pushing us down to 1600.  But barring those outcomes, this slide triggered a mountain of selling and any sustainable rally is two-steps forward, one-step back.  We should expect dips, not fear them.  Reactive traders buy high and sell low.  Proactive traders lock-in profits and buy dips.

Last Thursday’s plunge rattled traders and StockTwits’ SPY sentiment fell 25-points over a couple of weeks.  This is the lowest it’s been in recent history.  (The last time was mid-June and we know how that turned out.)  This somewhat contradicts Friday’s Yahoo Finance poll that shows many believe this is just a routine dip.  Timeframe is everything in the markets and Yahoo Finance readers could very well be different from StockTwits users.  I have nothing to back this up other than my intuition, but I expect Yahoo readers skew toward buy-and-hold where StockTwits skews heavily toward day-trading.  Both pieces are valuable insights into what comes next.  Likely we are getting closer to the end of this near-term dip, but the larger rally is at tad overdone and at risk of breaking down in the medium-term.  Timing is everything in the markets and hopefully these insights give us an edge.

TRADING OPPORTUNITIES
Expected Outcome:
Holding this 1650ish level through Tuesday shows we ran out of sellers and there are enough value buyers snapping up discounted shares to halt last week’s slide.  It is dangerous to catch a falling knife, but a four-day bottom is often long enough to end a downward move, allowing us to buy the dip.  Those that wanted to sell and short have already done so, relieving much of the selling pressure on the market.  Once that supply dries up, it is easier for the market to rebound.

Alternate Outcome:
Many holders remain nervous and uncertain.  They are watching the market intently and on the verge of selling either when the market crosses their stop-loss, or cutting bait when pain from losses gets too intense.  Hope is a poor strategy and everyone has their breaking point.  Nothing turns confident holders into emotional sellers faster than a tidal wave of red ink.

Trading Plan:
Wait for support and strength on Tuesday before jumping in.   Shorts have nice profits and can continue holding, but they need to protect these gains.  If the selloff doesn’t take another leg down after violating the 50dma, it signals most of the selling is already behind us and they need to take profits.

Plan your trade; trade your plan