Buy the fear

By Jani Ziedins | Intraday Analysis

Sep 18
S&P500 daily at 3:17 EDT

S&P500 daily at 3:17 EDT

MARKET BEHAVIOR
Stocks surged 15-points on news the Fed was not Tapering in September and continued charging higher through the afternoon.

MARKET SENTIMENT
This pushed us well past all-time highs at 1709 and put the hurt on anyone betting against the rally.  Now that we are back in clear air above previous highs, everyone with a diversified portfolio is sitting on profits and we no longer have sellers trying to get out at break-even.  With fewer people selling, it is easier for the market to continue making new highs.

Five-percent pullbacks always feel like the end of the world, that is why they work.  It spooks out the weak and seduces the naysayers to short.  When we have all this reactive selling after only a few point decline, it clears the market of weak holders and replaces them with confident owners.  Once the reactive selling dries up, the market rebounds on tight supply.  Don’t fear the five-percent selloff that feels like the end of the world, buy it.  The dip we have to watch for is a selloff that the crowd is making excuses for because everything looks so good.

The explosive nature of today’s breakout shows just how negative the market’s been.  The coiled spring sprung to the upside because everyone was positioned for a move lower.  I agree with the bears that this delay only puts off the inevitable and is fairly trivial in economic impact, but remember, we don’t trade fundamentals, we trade people and their portfolios.  When the crowd fears Taper, they sell proactively ahead of it.  This creates an asymmetrical trade.  Since modest Taper was already priced in, modest Taper would leave the market flat.  Anything above modest Taper leads to a rally and it takes a bigger than expected Taper to send the market lower.  Only one out three outcomes leads to a selloff, meaning the better trade was buying Taper, not selling it.

TRADING OPPORTUNITIES
Expected Outcome:

The market convinces us we are wrong just before proving us right.  It was tough being bullish at 1630, but clearly that was the better trade.  We’ve come nearly 100-points since then and now we need to figure out what comes next.  When in doubt, stick with the trend.  While we might check back to 1700 in coming days, finding support at this psychological level is bullish and suggests a continuation into the end of the year.  For 10-months now people have called for a pullback and that fear of the market is what keeps pushing us higher.

Alternate Outcome:
Every rally comes to an end and so must this one.  The thing to be wary of is an acceleration higher, signaling unsustainable buying.  We can continue holding gains, but be ready to step off and lock-in gains at some point.

Trading Plan:
Move trailing stops up to at least 1700 and possibly 1709.  We are sitting on nice gains and don’t want to give those away.  100-points over a couple of weeks is a big move and not a bad place for the cautious to lock-in profits.  This continues to be a bad place to short, wait for a violation of support before betting against this market.

Plan your trade; trade your plan

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About the Author

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.