Bipolar markets

S&P500 daily at 12:45 EDT

MARKET BEHAVIOR
Stocks are lower by midday as the market continues fretting over the Shutdown and Debt Ceiling.

MARKET SENTIMENT
Bulls have control for a couple of days, then it is bears turn.  That is what choppy markets do.  The thing to remember is a very small pool of traders are driving this volatility while everyone else is sitting on their hands.  We have short-term traders jumping all over each move, but the moves quickly fizzles when larger investors don’t participate in the buying and selling.  As I write this, the market is dipping under 1675 as weak bulls and confident bears that follow every tick are selling by the bucketload.  But what we are more interested in is what will happen when this small group finishes selling.  Will it shake free stock owners with a longer view that are already looking past the Shutdown/Debt Ceiling/Taper?  Will opportunistic traders with a longer view gladly buy the discounted shares from the impulsive sellers?  We will soon know the answer.

The problem many investors have is they follow tick-by-tick moves and that leads to impulsive trading decisions.  The market goes up and everything is fine, the next day it goes down and the sky is falling.  The truth is nothing changed from yesterday.  We are stuck with gridlock in DC, but we also know a deal will eventually be reached and this is nothing but a bump in the road.  Smart money is trading bigger economic factors and not paying attention to the near-term noise.  This is why these sharp moves higher and lower don’t go anywhere.

TRADING OPPORTUNITIES
Expected Outcome:
In choppy markets the worst thing is buying strength and selling weakness, yet that is the gut reaction of most traders that follow these daily moves.  Bulls who bought yesterday’s strength are selling todays weakness.  Buy high, sell low makes a poor trading strategy.  But before the bears gloat, they did the same exact same thing on Monday as they shorted the widely expected Shutdown, but were chased out by the Shutdown rally.  In choppy markets we buy weakness and sell strength, and by all measures we are in a choppy market until the situation in DC is resolved.

Another thing worth taking note of is how little the market declined on the political gridlock signals the size of the pop when this situation is eventually resolved.  This is not the November 2012 lows that leads to a powerful six-month rally.

Alternate Outcome:
With as little selling as we have seen ahead of this, that means plenty of downside remains if things turn out worse than expected.  So far investors are taking the longer-view and ignoring most of this political circus, knowing full well it will be resolved in a handful of days and selling the fear here is foolish.  But that theory only holds up as long as the market does.  Once traders’ screens are filled with red, they start questioning their resolve and eventually reach the point where the desire to get out overpowers the logic of staying in.

Trading Plan:
Early weakness pushed us below the 50dma and triggered a wave of stop-loss selling under this widely followed technical level.  Stay out of the way if selling accelerates, but if the move lower stalls, it means most of the selling is behind us and it is safer to own the market.  Longer-viewed investors can continue holding knowing this uncertainty will eventually pass in coming weeks.  Aggressive shorter-term investors can continue buying weakness and selling strength as this volatility will likely continue into next week.

Plan your trade; trade your plan