Short squeeze on signs of compromise

By Jani Ziedins | Intraday Analysis

Oct 10
S&P500 daily at 2:22 EDT

S&P500 daily at 2:22 EDT

MARKET BEHAVIOR
Stocks gapped higher on an apparent softening of the standoff in DC.  Stocks recovered the 50dma by midday as shorts scrambled to cover.  The surge reclaimed support at 1680 and unwound two and a half days of what now looks like fearful, herd selling.

MARKET SENTIMENT
While we don’t have an agreement from our politicians, the shift in rhetoric by both sides signals they are moving toward a workable solution.  This alleviates some of the worst-case fear that stubbornness would push us into default.  While there are still risks this fragile coming together will blow up over minor details, in typical market fashion, prices surge in anticipation of a deal and anyone waiting for the news confirmation will be a day late and a dollar short.

Much of today’s rebound is driven by short-covering and the rate of gains will taper, possibly even pullback after shorts finish covering.  Lets be clear, we haven’t ended the standoff and should expect ongoing political posturing to continue contributing to volatility, but the sharp selloff the last couple days shook free many of the weak holders, leaving far more confident owners in their place.

Source: Yahoo Finance 10/10/2013

Source: Yahoo Finance 10/10/2013

As we discussed yesterday, many long-viewed investors saw little reason to sell the near-term political uncertainty and this tightened supply once the more active traders ran out of stocks to sell.  Fundamentals and headlines don’t move markets directly, only supply and demand does that.  No matter what the news or trader expectations, when we run out of sellers, we bounce on tight supply.

TRADING OPPORTUNITIES
Expected Outcome:
Know when to hold’em, know when to fold’em.  Savvy traders sell strength and buy weakness, but most often our gut instinct is to buy strength and sell weakness.  There is a very elusive line between confidently holding through a temporary dip and stubbornly riding the market lower.  That fine line is the difference between winning and losing.  Of course the least stressful trading strategy skips this ambiguity and sells strength, letting others debate holding or selling the weakness.

While the market is going through a temporary reprieve from the risks of default, this political battle is far from over and we are simply delaying the day of reckoning.  While a meeting of minds shows a more conciliatory side of our politicians, expect the rhetoric (and volatility) to pick back up in coming days and weeks.

Alternate Outcome:
While our politicians can be commended for moving a few inches off their initial positions, they have not changed their goals and are simply buying more time to fight for their positions.  Recent flexibility from Obama is rekindling hope in some that they can continue pushing on Obamacare.  While that is obviously a non-starter, that threatens to return this standoff to square one and reignite fears of a default.  Just when we start feeling better about the political process, our elected representatives do something to disappoint us.

Trading Plan:
Tough day to be a short and shows why counter-trend trades need to harvest profits early and often.  On the other side, bulls should expect some of this euphoria to pass as the political bickering resumes.  There is little urgency to chase this rebound since we will likely consolidate between 1680 and 1700 until the debt ceiling is actually lifted.  At the same time, the market is buyable for anyone looking to get in.  Keep a stop under the 50dma and shorts can use this same level to re-short the market if negotiations breakdown and a default is back on the table.

TSLA daily at 2:22 EDT

TSLA daily at 2:22 EDT

INDIVIDUAL STOCKS
AAPL is up, but failing to keep up with the broad market’s gains.  While the rally back to $500 was impressive, the last few weeks of sideways trade killed most of that momentum.  Everyone still loves AAPL, but that is its biggest problem.  Companies like NFLX and FB staged spectacular turnarounds because they were some of the most hated stocks following their high-profile selloffs.  AAPL never reached that wide level of disdain and ridicule, meaning it is not ready for a similar comeback.

TSLA is still holding above the 50dma.  A breather after such a strong move is normal and expected, but watch for a wave of stop-loss selling and shorting to hit the stock if it dips under $160.  If this leg stalls, the stock is buyable.  If it accelerates, watch out as the crowd rushes for the exit at the same time.  Remember, TSLA is just a stock and a meaningless piece of paper once it stops going up.  If you love the car, buy one, but don’t fall in love with the stock.

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.

jeff October 10, 2013

I totally disagree with this comment.
“Savvy traders sell strength and buy weakness, but most often our gut instinct is to buy strength and sell weakness.”

It is in fact more difficult to buy strength and easier to buy weakness. That typically what the avg investor does is buy when a stock is down only to hold a stock that continues to go down or goes nowhere for a long time.

    Jani Ziedins October 10, 2013

    You make a good point, there is a lot of nuisance I left out of that overly simplified statement. Traders are emotional beasts and most often their gut leads them to make the exact wrong call. (herd psychology and supply and demand at work) A stock that is too high keeps going higher. A stock that looks like a great bargain keeps going lower. The obvious breakout fails and the certain breakdown bounces.

    My original comment referenced how two-days ago traders were selling on fears of a collapse. Today they are buying because everything is okay. And eventually we will find out both are wrong.

Steve October 11, 2013

Jani,

I enjoy reading your market commentary every day. You seem to have a keen insight into the psychological reasons that the market and it’s participants do what they do and why. My question to you is did you learn this on your own through experience? Are there any books or websites you can recommend to learn more about market psychology? Thanks in advance!
Steve

    Jani Ziedins October 14, 2013

    Nothing beats experience. With profession like Law, Medicine, Engineering, or Airline Pilot, no one expects to read a $15 book or attend a two-day weekend seminar and jump into the courtroom, operating room, or cockpit, yet many people think they can hit the ground running in the market with weeks or months of training and experience. Over the years I’ve read hundreds of books and I try to explore a large diversity of thoughts and ideas from momentum to value to efficient markets. There are nuggets of truth and insight in everything out there, including POVs that say it is impossible to beat the markets. From there it was simply making tons of mistakes and learning from them. There is no silver bullet or magic trick.

    As for books, some of the ones that stand out are How To Make Money in Stocks, Random Walk Down Wall Street, The Only Three Questions that Count, and Intelligent Investor. That is a nice diverse place to start.

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