Time for a break?

By Jani Ziedins | End of Day Analysis

Oct 29
S&P500 daily at end of day

S&P500 daily at end of day

MARKET BEHAVIOR
Another up-day, making it thirteen out of the last fifteen.  The market continues defying both bears and gravity, but how long can it last?  The rate of gains slowed after we passed 1740 as traders grew more cautious of these dizzying heights.  So far the market is giving every indication we transitioned to a directional phase and that means countless new highs are ahead of us.  But like every move in the market, it won’t be straight line and we should expect an occasional step-back for every two-steps forward.

MARKET SENTIMENT
Bears are obsessing over the low-volume.  In their view, we cannot trust any move that doesn’t have a lot of people participating in it.  But here is the thing, traders do more than just buy and sell.  In fact, they do a more holding than anything else.  We are rising on low-volume because most owners don’t want to sell and that speaks “volumes”.

Every dip this year was a buying opportunity and anyone who fell for the head-fakes doesn’t want to be fooled again.  While this market will top like every one before it, it won’t be because of owners’ complacency.  That is another popular misconception.  When owners are disinterested in selling, that keeps supply tight and makes it far easier to rally on modest demand.  Low-volume strength was the secret sauce for the first-six months of the year, and early indications are the same behavior will close the year too.

But that is the two-month outlook.  Trading over the next few days will responded to different currents.  It is really tough for big money to buy a market that is up nearly every day over a three-week period.  We saw a lot of short-covering and breakout buying push us higher, but these active traders represent a small sliver of the market’s capital.  Soon these gains will stall when big money doesn’t continue buying this nearly non-stop move higher.  We don’t need a big dip to interest underweight money managers, but they need something to ease their conscience that they are not buying the top.  It is perfectly reasonable, normal, and healthy to see this string of up-days take a break and the market to re-test support at 1740.  That is actually far more bullish and sustainable than continuing higher without resting.

The potential catalyst for a modest pullback is the Fed meeting.  Most traders, including myself, are not expecting a change to QE, but that means it is already priced in.  We don’t need bad news to soften the market and could actually dip on good news if the market sells the news.  While I still believe most of the Taper trade is long behind us, it could easily inject a little volatility, leading to a near-term re-test of support before we brush it off and resume the up-trend into year-end.

TRADING OPPORTUNITIES
Expected Outcome:
While I think the up-trend will continue, we should expect some near-term weakness that allows the market to consolidate recent gains.  Depending on a trader’s timeframe and risk-tolerance, they can either choose to hold through the dip, sell into strength, or for the most ambitious and nimble, take a stab at trading the counter-trend move.  I still expect the market will make new highs in coming weeks, but near-term down-days are an important part of moving higher.

Alternate Outcome:
There is no reason the market needs to pause and could actually accelerate into a climax top.  These things go further and longer than anyone expects and the least expected outcome is another week of non-stop up-days.  But this is a less likely outcome and to succeed in this game we need to always consider the risk/reward of any trade.  While it is conceivable we could continue higher for another few days, how much downside risk are we exposing ourselves to for a few extra points of upside?  The goal isn’t to make all the money, just the easy stuff.

Trading Plan:
This is the wrong time to be initiating new longs.  The market already expects no change from the Fed, so there will not be a sustainable pop on the news.  In fact, if there is a pop, that could be a good opportunity to lock-in recent profits and looking for a better level to buy back in.  Longer-term traders can hold the volatility because so any near-term weakness looks like it will simply be part of the process of moving higher.

AAPL daily at end of day

AAPL daily at end of day

INDIVIDUAL STOCKS
AAPL had an ugly reversal and while it didn’t violate support, this is unlikely to be a one day event.  $500 is easily in play and risks go up if we fail to hold the 50dma.  A lot of traders and investors are excited about the value in this stock, but that increases the risk of it being over-owned.  When everyone loves something, who is left to buy it?

TSLA had a dramatic day, but managed to pull out of it and actually close up a dollar and a half.  While a lot of traders jumped at the chance to buy the stock near $150, I’m not sure the selling is done.  Last Friday Musk said the company didn’t deserve this valuation and it is really hard to argue with the CEO.  If the stock reclaims the 50dma on elevated volume, then the party is back on, but at this juncture, expect prospective buyers to step back and wait and see what happens.  Their lack of buying could lead to further weakness and even more attractive levels for them to buy shares.  They will not be in a hurry if they think the stock will get even cheaper.

NFLX found support at the 50dma, but volume was barely average and not very convincing.  This looks more like dip buying than major institutions using the weakness to add to their positions.  Wait for the high-volume confirmation before buying the 50dma bounce.  On the other side, owners need to have a plan to take profits.  Maybe they sell a violation of the 50dma, or they wait for a breach of support at $270, but either way, have a plan to take profits.  It is always better to be out of the market wishing you were in, than in the market wishing you were out.

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.

LT October 30, 2013

I hope you never discontinue this blog. Great article.

    Jani Ziedins October 30, 2013

    I’m glad you appreciate it. Most successful traders claim a trading diary is one of the most important parts of their trading success. I feel the same way, but rather than keep my ideas and notes to myself, I put it out there for the world to see. For me, I find the public disclosure keep me honest since it is impossible to defend an emotional decision. In that way, CM makes me a better trader and is self-serving, so as long as I keep trading, I will continue blogging about it.

Jonathan October 30, 2013

I agreed. Your posts are a must read during my busy work day.

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