Stocks set another record high in early trade, but it was all downhill from there as we closed lower by half a percent. The last 15-trading sessions put together a tremendous run, so it is no surprise a down day was waiting for us. Markets go up and markets go down, and today’s price action was simply one of those down days.
I heard a lot of chatter about an outside day or an engulfing candle. That is when both today’s high and low are higher and lower than yesterday’s high and low. While I’m not real big on trading technical signals, we use this widely made observation to figure out what other people are thinking and how they will trade it.
By most accounts this is a negative pattern, but in this case it will be a self-fulfilling prophecy. When prospective buyers expect lower prices are imminent, they wait for the market to come to them. While holders remain confident and are not worried about a few down days, if buyers sit on their hands, prices go down no matter how confident holders are. Many professional money managers are behind their benchmarks heading into the last two months of the year. While they feel pressure to chase, they are reluctant to buy a market that was up 13 out of the last 15 sessions. They will wait for the market to come in a couple percent before they feel good about buying the dip. That pressure to chase will keep this selloff relatively shallow as big money buys every dip, but over the medium-term, a little sideways consolidation is constructive and supports a sustainable rally into year-end.
The catalyst for today’s drop was the Fed staying the course. In a vacuum, this would be considered bullish because it continues the easy money policy. Things get more complicated when we factor in what other traders expected and how they were positioned. Most saw this coming from a mile away and were already positioned for an uninterrupted continuation of QE. This leads to a buy the rumor phenomena as traders act in anticipation of an event. But since everyone say this coming, there were few left to buy the news today and we fell due to the vacuum of demand. Remember, markets only move when people trade, and people only trade when they change their mind. This Fed meeting didn’t change anyone’s mind, and thus no one bought the news.
Expect further weakness over coming days as traders sit on their hands following today’s engulfing candle. We will likely slip to prior support near 1740 before dip buyers jump to the rescue. This could be a couple of days or couple weeks, but the important thing is this is only temporary weakness and we will resume making new highs before the year is over.
If the expected outcome is a little down and then a little up, then the alternative is a big move either direction. Given how far we came over recent weeks, it is hard to see an explosive move to the upside. With the budget and debt ceiling pushed to another day, there is little hanging over the market to act as an upside catalyst when the risk is removed. Given where we are, there is more risk to the downside if we are blindsided by a new risk element not already factored in. This isn’t Taper or Default, but something all new. I don’t know what or when, all we can do is wait and respond proactively when we see it.
Anyone out of the market, here is your chance to get back in. We will likely see a dip to support near 1740. Depending on how aggressive dip-buyers are, we might not even fall all the way to support before desperate buying turns the market around. Or we could see the market penetrate support and set off a wave of stop-losses before rebounding. No one has a crystal ball and we simply have to wait for the situation to develops. Bulls should not try to catch a falling knife if we start selling off. Wait for it to find a bottom and stabilize. There will be plenty of time to get back in when we find support. Better to be a little late than a lot early. On the other side, bears with a short positions need to recognize this is a counter-trend trade and that means taking profits early and often. Making money in the market is easy, the hard part is keeping it. Bears have seen a lot of good downside trades and they would be having a good year if they were disciplined about taking profits.
Plan your trade; trade your plan
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.