Volatility increases

S&P500 daily at 2:18 EDT

MARKET BEHAVIOR
A wild ride this morning as we gapped lower, surged higher, and then plunged under the early lows by midafternoon.

MARKET SENTIMENT
Volatility is often a sign of shifting trend as many stubbornly continue trading what has been working, but their declining numbers mean they don’t hold the same sway over the market.  For the last 12-months every dip has been buyable.  While most resisted buying the dips in the first half of the year because they expected a pullback, now everyone is buying the dips because that has become the most obvious trade.  But what happens when everyone starts buying the dips?  After a while the crowd ends up fully invested and there is no one left to buy.

The last few months has seen a dramatic shift in sentiment as we went from countless headlines of doom and gloom to a complete lack of fear.  Markets move when people change their mind and as people warmed up to the market, their buying pushed us to all-time highs.  Now that we are at a point where everyone feels pretty good, there are fewer bears left to convert to bulls.  That means price gains will slow down.  Even more worrisome is this new, large pool of bulls is ripe to change their minds their selling will push us lower.

While sentiment is not an exact science, it gives us insight into probabilities for a move.  While we can easily continue making new highs, the large shift in sentiment makes us vulnerable to a pullback.  While we cannot use this as a timing signal, it gives us an idea of the actual risk/reward of owning the market.

TRADING OPPORTUNITIES
Expected Outcome:
Fear and uncertainty is only just starting to creep back into the market.  By nature the market is a fearful creature and the last six weeks has been unnatural.  Nothing brings fear back into the market like sliding stock prices.  It really doesn’t matter what reason people attach to it, they are simply trying to rationalize what is nothing more than the laws of supply and demand taking over.  While it seems likely we are destined test the 50dma in coming weeks, it won’t be a smooth ride and expect the choppy volatility to continue.

Alternate Outcome:
Every dip is buyable until it isn’t.  We are only 1.5% from all time highs and it is certainly premature to be calling a top.  Every dip purges excess from the markets and this choppiness might be all we need to refresh the market and set the stage for the next leg higher.  If the market recovers recent losses, that shows dip-buyers are alive and well.

Trading Plan:
Given the large shift in sentiment recently, it is hard to justify the risk/reward of buying such a minor dip.  Let this move play out and we will likely get the opportunity to buy at even more attractive levels in coming weeks.

Plan your trade; trade your plan