AM: Unexpected strength

By Jani Ziedins | Intraday Analysis

Aug 20
S&P500 daily at 3:24 EDT

S&P500 daily at 3:24 EDT

AM Update

Stocks bounced following yesterday’s slide.  We traded up to the 50dma as both sides watch intently to see what happens next.  The market remains comfortably inside the summer’s trading range, but every pullback this year stalled shortly after challenging the 50dma.

The market found a floor after briefly violating the 50dma.  The million dollar question is if we bounced because we ran out of sellers, or if all the Johnny-come-lately dip-buyers are temporary propping up the market before the next leg down.   To figure that out we need to see what people think and how they are positioned.

This morning’s bullish sentiment on StockTwits’s fell to a paltry 34%.  While not a scientific sample, it shows many people don’t believe in this market and are expecting lower prices in the near future.  Some could make the argument StockTwits users are more engaged and informed than the average market participant and their opinions are more insightful than contrarian.  While there is plenty of logic in this assertion, it is easily testable.  All we need to do is look back at the last dip in June to see what StockTwits users thought.  Coincidence or not, this low coincided with the last time StockTwit’s SPY bullish sentiment was below 40%.

Source: StockTwits 8/20/2013

Source: StockTwits 8/20/2013

Obviously the next argument is, this time is different.  While we are down from different headlines, the market participants are all the same.  How they responded to that last selloff will have parallels to how they respond to this one.   The whole reason contrarian trading works is people trade their opinions.  Bears are in cash or short.  Bulls are long and on margin.  When the crowd shares a similar opinion, that means the crowd already acted on those insights.  In this case it means 66% of a group of StockTwits users are underweight or outright short this market.  They already sold and there is little these traders can do to further pressure the market.  Once all the like-minded people with bearish outlooks sell, supply dries up and the market responds “irrationally” by bouncing at the exact moment when everyone expects it to collapse.

No doubt the market could continue lower as other confident holders start to doubt their positions and sell ahead of the impending collapse, but that is the nature of the game.  No one knows what will happen next, but the successful trader looks for opportunities when the risk/reward are in his favor.

Expected Outcome:
Today’s bounce is an excellent buying opportunity with clearly defined risk.  The bear thesis predicted falling under the 50dma would set off a second wave of stop-loss and emotional selling.  That was supposed to be the trigger that accelerated the selloff.  Yet we bounced this morning as the stop-loss and emotional sellers failed to materialize.  When the market doesn’t respond as expected, we need to reevaluate our outlook.  Bears expecting a swift leg down need to be careful when the market refused the perfect setup for one.  I don’t buy bottoms,but I do buy strong moves the opposite direction from what everyone expects.

Some will criticize my call a couple of weeks ago where I expected support at 1700.  Obviously I was wrong, but in the markets every trader must make a critical decision, do they need to be right or do they want to make money?  This is important because these are two very different things.  My goal is making money and I’m actually glad I was wrong.  Like most disciplined traders I was stopped-out at 1695, locking in earlier gains.  From there, the market continued falling, but this is where the magic happens, the selloff allowed me to buy back in this morning at 1655.  Where we go from here is yet to be seen, but I have the opportunity to make 40 points of additional upside simply because I was wrong two weeks ago.  Given outcomes like that, I have no problem being wrong and I hope many readers feel the same way.

Alternate Outcome:
Every dip this year was buyable.  No doubt the crowd is starting to notice and when too many people recognize and trade something, it stops working.  In this case it isn’t the dip buyers that will take us down, but the confident holders that keep holding the dip.  There is nothing that shakes confidence like a screen full of red ink.  Like any dam that bursts, it starts with a crack and accelerates from there.  No matter how confident owners are and what the fundamental outlook is, once panic grips the markets, people sell first and ask questions later.  The best protection is disciplined use of stops.  When we stick to our rules, we can take calculated risks.

On the other side, anyone short the market needs to be careful.  I would take profits, not add new shorts.  The market is flirting with reclaiming the 50dma and that will trigger a short squeeze.  Remember, the goal isn’t to make all the money, just the easy stuff.  If we nose over, there will be time to jump on the short bandwagon again.

AAPL daily at 3:24 EDT

AAPL daily at 3:24 EDT

Trading Plan:
This morning’s bounce makes for a low risk, high reward entry.  Buy the bounce with a stop under 1650 or 1645.  We are risking 10-points with a potential upside of at least 50.  Even if the odds are against us, this highly asymmetrical trade is attractive.  When we combine other factors such as the sentiment skew and lack of a plunge following yesterday’s selloff, the odds are actually on our side too.  At some point this rally will end and we must be ready for it, but when in doubt, stick with the trend.

AAPL gave back yesterday’s gains and is retesting $500.  This was key support last year and is an important round number to watch here.  While my preference taking profits after a strong run, traders can use a trailing-stop under $500 to protect recent gains.  There are a lot of Johnny-come-latelys following Icahn’s tweet and in anticipation of the iPhone refresh.  Is the ‘cheap’ iPhone already priced in, or will it catch a lot of people by surprise?  My guess is most already expects it and thus already priced in.  Unless AAPL shocks us with something new and unexpected in Sept, this feels like a buy the rumor, sell the news trade.

Plan your trade; trade your plan


About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, 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 children.