AM: Testing the 50dma

AM Update

MARKET BEHAVIOR
Stocks traded sideways at the 50dma following yesterday’s 1.4% selloff.  Volume for the dip was only a few percent above average, surprisingly light for the largest loss in months.  This shows many money managers remain on vacation and the lighter volume exacerbates volatility.  Light volume can also be explained by confident holders unwilling to sell dips and few are rushing for the exits.

MARKET SENTIMENT
Yesterday’s one-way selling is taking a break as most wait to see what happens next.  This pause alleviates some of the anxiety and gives traders time to make rational and deliberate decisions.  That doesn’t mean the selloff is over, only that the initial wave of emotional selling came and went.

Ironically the most bullish move is more selling.  Dipping under the 50dma triggers a second wave of stop-loss and emotional selling, setting the stage for a capitulation bottom.  This is exactly what happened in June, leading to our recent 140-point surge, but that is only one possibility.

Yahoo Finance had another insightful poll this morning.  Over 60% of respondents are either not worried about the dip or buying this weakness.  That shows complacency creeping in, not surprising since every other selloff this year ended in a rebound to new highs.  The challenge with sentiment is figuring out how far this will go before toppling over.  We certainly have a majority, but do we need 80% before it becomes unsustainable?  Just like everything in the market, there is no clear answer and it largely depends on how quickly sentiment shifts as the market dips.  A rapid selloff accompanied by a sharp reversal in sentiment will find a bottom quickly.  That is what happened in June.  A slower grind lower as stubborn owners refuse to sell will take longer and is typical of an erosive bear market that takes us down a few points at a time.  Plunges are scary, but bounce quickly.  Grinds lower don’t scare us, but they do more damage as the series of lower highs drains our accounts under our noses.

TRADING OPPORTUNITIES
Expected Outcome:
The market is at a critical juncture and the best place is cash until we have more clarity.  While this could be another buyable bounce, we want to see the market hold these levels for a few more days before we assume the market found a bottom.  Temporary dip-buying can prop up a market for a couple of days, but holding for four days demonstrates real support.

Shorts can stay short, but should move their trailing stop down to 1670 to protect recent gains.  In the choppy summer market, we are best served by taking profits early and often.  That has been the best counter-trend trade this summer and is not a bad decision here.

The most bullish signal will be a violation of the 50dma followed by a strong reversal.  That shows stop-loss, emotional, and short selling exhausted itself in a capitulation bottom.  Bears expect us to crash through the 50dma but if that doesn’t happen, they have to be flexible enough to recognize further emotional selling is not happening and they need to lock in profits.

Alternate Outcome:
Without a doubt the market is becoming more and more complacent as proven by the Yahoo Finance poll.  All these confident holders are a few points from becoming panicked sellers.  Recent economic concerns over earnings from WMT, CSCO, and M are giving some money managers doubt and their lightening up could be the start of something more.  Remember, markets only move when people change their minds and adjusting outlooks based on these bellwether companies could be the straw that broke this rally’s back.

Trading Plan:
Patience is the name of the game.  While we come to this with biases and expectations, let the market make its move first.  It is better to be a little late than a lot early.  A bounce off the 50dma early next week is buyable.  Breaking the 50dma by itself is not automatically bearish.  We need to see an acceleration that shows previously confident holders are rushing for the exits.  If a dip under the 50dma quickly stalls, that means selling is drying up and we can buy the rebound above the 50dma.

INDIVIDUAL STOCKS
TSLA closed the earnings gap and is down 10% from the post-earnings high.  A lot of people bought the earings breakout and shorts covered, but since then few have been willing to pay top dollar and are waiting for better prices.    This stock has a history of strong surges followed by month-long consolidations, so even under best conditions we should expect sideways trade here.  The bigger test will be when the 50dma catches up in coming weeks.  Will we get another bounce, or will that be an excuse for people to lock-in profits?  The next greater fool theory applies to all momentum stocks no matter how sound the underlying fundamentals.  TSLA will top when there is no one left to buy.  Just ask anyone who held AAPL through the record-setting iPhone5 launch last year.

Speaking of AAPL, it is pausing at $500 following the Icahn pop.  While a lot of retail investors are excited to ride on his coattails, it is fairly safe to assume he waited until after he bought his entire position before promoting it to the world.  That means his buying will no longer prop up the stock and he is simply along for the ride like everyone else.  In fact, depending on how much he bought, he could be responsible for the some of the recent rally up to the 200dma.  We will soon learn what happens without his massive war chest bidding up the price.

The market is eagerly awaiting AAPL’s “low-cost” phone so it can stem the market share losses to cheaper Android phones.  The thing investors need to worry about is if this iPhone5c is too successful and actually becomes AAPL’s leading seller at the expense of its more profitable big brother.  There is precedence in the iPod lineup.  Soon after launching the smaller and less expensive iPod mini, it quickly became AAPL’s best seller.  The Mini was eventually replaced with the Nano and now the larger and more expensive full size iPod is on life support.  If the iPhone5c’s price and profits are half that of the iPhone5s, AAPL will eventually need to double sales just to stay where they are at.  This is why many are concerned about hardware price wars catching up to AAPL’s stellar profit margins.

Plan your trade; trade your plan