Stocks pulled back after setting record highs Monday morning. This continues the sideways consolidation near 1,850 and we remain at the upper end of the recent trading range.
Monday’s push to new highs triggered a wave of breakout buying and short-covering, but the surge didn’t last long as we stalled and retreated from those early highs. This suggests few are willing to buy the breakout because either they are already fully invested, or they don’t trust these valuations.
Sometimes breakouts are the launching pad for strong upward moves, but other times they are the last gasps of buying before demand dries up and prices slide lower. While technicians believe all the information they need is contained in the chart, what market participants are thinking is even more important. Did we breakout because a heavy weight holding the market back was suddenly lifted? Or was it because all the good news has finally been priced in and there is little incentive for people to buy?
Resolving Fiscal Cliffs and Euro Contagion lead to big moves higher because many traders were reluctant to own those risks, but once those clouds cleared traders embraced the market. More recently we had bouts of doubt over Emerging Markets and domestic economic data, but neither of those headlines whipped the market up into a frenzy. It is harder to say these were heavy weights holding us back and removing these obstacles will trigger a run to 1,900. On the other hand, its been a while since we had a real scare. The apathetic attitude held by many traders leaves us vulnerable to the next headline scare.
Expected Outcome: Stalling near upper end of trading range
While this rebound can continue, we are near the upper end of a potential trading range and this affects the risk/reward of initiating new positions. Following yesterday’s fizzled breakout, that shows there is not a lot of explosive upside in this market, meaning at best we will grind higher. On the other hand, we are 100-points from recent lows and that creates a lot of downside risk if buyers remain hesitant to buy above 1,850.
Recent weakness and volatility left many people reluctant to trust this market. Recent sellers are slow to change their mind and they remain on the sidelines. This means the market is currently not over-owned since there is so much money available to chase another let higher.
Buy weakness and sell strength. We are near the upper end of a potential trading range and the risk/reward suggests we be more defensive than offensive. Failing to reclaim 1,850 demonstrates a lack of demand at these levels and likely means further weakness in the near-term. If nothing else, this is a good place to take profits and wait for the next high-probability trade.
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.