Stocks recovered two-thirds of recent losses on Friday following a stronger than expected employment report. We gapped higher at the open and held these gains through the close. Reclaiming prior support at 1,800 is a big win for the rally and the market is establishing a trading range between 1,780 and 1,810.
Bulls are breathing a sigh of relief as this employment report snaps a five-day losing streak. While the modest selloff made holders uneasy, it wasn’t deep enough to convince a large number of them to dump their shares. Much of the recent selling was likely bears shorting the weakness and Friday’s strength forced many of them to buy back those shorts for a loss. Short-squeezes are strong, yet temporary and the bigger question following Friday’s rebound is if this strength will attract a sustainable wave of new buyers to the market.
With bullish sentiment at levels we haven’t seen in years, it is hard to get excited about owning this market. The challenge of trading sentiment is it is just as hard to pick a top in sentiment as it is to pick a top in the market. While sentiment doesn’t give us a timing signal, it does provide insight into how large resulting moves might be.
Stocks only move when people change their minds. This is when they adjust their portfolio to reflect their new outlook and the resulting buying and selling moves prices. The problem with widespread bullish sentiment is there are fewer people remaining to convert to buyers and that limits the potential upside. On the other hand, a huge crowd of bulls creates an ample supply of prospective sellers. While we can continue higher as we attract the last of the holdouts, there is far more risk of a large downside move simply because of how crowded the bull side has become in recent weeks.
Trends are more likely to continue than reverse, but the larger potential move is to the downside. How each person trades this is up to them. Someone swinging for the fences will short the market since that is where the biggest pile of money is. Someone happy with small gains will continue squeezing nickels and dimes out of the rally.
Treasuries keep falling in price, chasing many out of that market and they need to find a place to park their money. Given what a great year it’s been for equities, many will be tempted to chase this strength. Their buying can continue pushing us longer and higher than anyone imagines.
The market is consolidating in the 1780 to 1810 range. We can buy the weakness and sell the strength until the next directional trade breaks out or breaks down.
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.