Sell the fear?

By Jani Ziedins | End of Day Analysis

Apr 07
S&P500 daily at end of day

S&P500 daily at end of day

End of Day Update

MARKET BEHAVIOR
Stocks sold off for a second day, slicing over 50-points from Friday’s intraday highs.  We are just above the 50dma, but under 1,850 support.  Volume was elevated, but only just above average, so this move doesn’t qualify as a stampede for the exits.

MARKET SENTIMENT
Easy come, easy go.  Friday we set record highs following a respectable employment, but its been all downhill since then.  While there are no major headlines to speak of, many high-fliers are crumbling and that is dampening the mood in the rest of the market.  We haven’t seen major waves of selling indicating most owners are largely holding through the dip.  This weakness is primarily coming from the absence of demand as anyone with money was reluctant to buy all-time highs as we ran out of momentum chasers.

Typically there are two types of large selloffs.  The first is the familiar headline driven panic selling.  This is typified by overwhelming fear the market is about to crumble because some structural flaw has just been uncovered.  That doesn’t seem to be the case here since the best most people can come up to explain this weakness is “profit-taking”.  The other type of extended decline is the “stealth” selloff.  This is the one that sneaks up on us by lulling traders into complacency.  These are the declines that no one notices because they are trivial by themselves, but over time they add up.  The last-two days of weakness is many things, but stealth is not one of them.

The emotion and pain of the recent plunge sent most with a weak stomach running for cover.  Most of these are the late to the party momentum chasers and breakout buyers.  They are the ones that first showed losing trades and are the most likely to impulsively pull the plug.  Now that many of these flaky owners have jumped ship, they were replaced by more confident buyers willing to own the uncertainty and this is the start of the bottoming process.  This selloff will finally end when the supply of sellers dries up after all who were inclined to sell already sold.  Given how transfixed the market has been by the last two days, we are probably getting close to this capitulation point.

TRADING OPPORTUNITIES
Expected Outcome: A little more weakness before finding a bottom under the 50dma.
Short-term traders are well aware of this weakness and many sold as we undercut their stop-losses.  This autopilot selling is provided much of the downside pressure, but now that many of these traders are out of the market, that overhang has been removed.  What hurt us today cannot hurt us tomorrow.  While we likely have some traders barely holding on and slipping under the 50dma will flush this last wave out, once these stragglers sell, expect the market to run short of supply and bounce.

Alternate Outcome:
Nothing shatters confidence like losing money.  No matter how confident we are, when everyone else is rushing for the exits, it forces us to wonder if they know something we don’t.  All of us have our breaking point before we succumb to the emotional pressure and join the herd.  If the market doesn’t find a bottom shortly after breaking the 50dma, the selling will likely continue as previously confident holders start selling first and asking questions later.

Trading Plan:
The market will likely find support near the 50dma in coming days, but if it doesn’t bounce in a v-shaped rebound, it needs one last plunge lower before returning to 1,900.  Long-term traders should ignore this volatility, but short-term traders can look for an interesting entry point when the crowd is convinced we are on the verge of a dramatic plunge lower.

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.