Pulling back to support

S&P500 daily at end of day

MARKET BEHAVIOR
Stocks dipped to support at 1700 in early trade.  100-points over a few weeks is a big move and retesting support should not come as a surprise; the bigger question is how the market responds.  We are at the upper end of the summer’s trading range and that gravity is trying to pull us back in, but every trading range ends and so will this one.  The transition from summer to fall is often a directional catalyst and why Sept and Oct often lead to large moves.  So far big money is more willing to buy than sell and that pulled us off the 1630 lows.

MARKET SENTIMENT
Nothing like 30-points of selling to rain on the Bull’s parade.  Current headlines promote an impending showdown over funding Obamacare and a potential govt shutdown.  From what I gather, many are not bearish because they expect fiscal calamity, but because they think other people will panic.  That is a very nuanced, but important distinction.  Selloffs happen when people become scared and sell, not when they expect others to become scared.

To breakdown under the strain of DC politics, we need people to be caught off guard by the headlines and right now a budget showdown is widely expected.  Anyone afraid of these impending headlines is already out of the market, meaning there are fewer left  to sell the news.  Further, recent examples of political discord were buying opportunities, not a cause for concern, so expect far fewer traders to impulsively sell the headlines.  That likely means this “sell the rumor” dip will be a bump in the road.

Markets don’t move on what traders expect others to do, but how they trade their accounts.  Most of us are wired with the same biology and learned trading from similar schools of thought.  That means more often than not, what we see and think is what everyone else is seeing and thinking.  If we are afraid of an impending collapse and sell ahead of time, a lot of other people did the same thing.  This shared view is what leads to the appearance irrationality.  People are convinced the market should do one thing, yet it does the complete opposite.  The market isn’t acting irrationally, it simply reacts to a supply and demand the only way possible.  When the crowd sells early, it prices in what everyone is afraid of and paradoxically the market will go higher when the news comes out because there is no one left to sell.  Right now the crowd anticipates problems over Taper and debt ceilings, meaning they already acted on this “insight” and it is already mostly priced in.  It is irrelevant that we are all-time highs, the only thing that matters is most people are aware of this impending calamity and those that fear it already sold.  This doesn’t mean we cannot selloff another couple dozen points, but it does mean much of the downside is already priced in and we have far less to fear than the naysayers claim.

TRADING OPPORTUNITIES
Expected Outcome:
Stocks retested support as expected, so no one can claim the sky is falling just yet.  Even another 20-points of selling is a normal 50% retracement of recent gains.  Two-steps forward, one back.

Alternate Outcome:
The market is far less fearful of the debt ceiling.  Politicians are quickly becoming the boy who called wolf with all this grandstanding and posturing.  While it will be ugly, most expect a deal to get done at the last-minute and is what the market is pricing in.  What isn’t priced in is a catrosphoic game of chicken where both sides go down in a ball of flames.  While the high probability outcome is a workable resolution, the black swan is a complete breakdown of reason, leading to a far larger move.

Trading Plan:
While the high probability outcome is higher, we must respect the risks and honor our stop losses.  Bouncing off support is buyable.  Slicing through the 50dma is shortable.

Plan your trade; trade your plan