Churn ahead of the Fed

S&P500 daily at 2:19 EDT

Midday Update

MARKET BEHAVIOR
Stocks gave up yesterday’s opening gap, briefly falling under 1,780 support.

MARKET SENTIMENT
Monday was the bounce bulls and dip-buyers were hoping for, but they were never able to build on early momentum.  Almost all of the buyable dips this year accelerated following the bounce.  This stalling likely indicates this is not the real buyable bottom.

All eyes are on the two-day Fed meeting, but will the outcome change anyone’s mind?  Will it turn bears into bulls, or bulls into bears?  The only thing that moves prices is when market participants change their mind and alter their portfolio allocations.  That resulting buying and selling is what moves markets.  Will Taper turn bulls into bears?  Will no-Taper turn bears into bulls?

No doubt we will see near-term volatility as short-term traders try to game the headlines coming out of the FOMC meeting tomorrow, but after that passes, expect the market to return to its previous trajectory.  Since the Thanksgiving high, buying stalled as few are enthusiastically buying these new highs.  The last couple months has seen a dramatic shift from 20% bulls to 60% bulls.  Converting cynics into buyers fueled the 150-point surge off the October lows, but with so few cynics left to convert, we might be running into demand problems.

TRADING OPPORTUNITIES
Expected Outcome:
The challenge for bulls is yesterday’s pop pulled a portion of the no-Taper buying forward, meaning there will be fewer left to buy the news when it comes out Wednesday.  Today’s weakness shows many are not willing to follow the dip-buyer into this trade.  Maybe they don’t believe it, or maybe they are already in the trade and don’t have extra money to buy more.  The challenge is when so many people already believe in a move, there are few left to keep pushing prices higher.

Alternate Outcome:
The last few weeks of churn removed some of the market’s recent excess, setting the stage for a continuation.  Sentiment can remain at bullish extremes for extended periods of time and is a secondary indicator.  When in doubt stick with the trend and in spite of modest weakness, the market is still in an uptrend.

Trading Plan:
Now we simply wait and see what the Fed has to say and trade the resulting move.  Given the high level of bullishness already in the market, there is not a lot of explosive upside in the market.  On the other hand, we are vulnerable to a herd selloff if the crowd loses its nerve.  While the high probability trade might be higher, the bigger move potential is lower.  Trade those conditions according to your style, risk tolerance, and plan.

Plan your trade; trade your plan