Finally a breakout

By Jani Ziedins | End of Day Analysis

May 27
S&P500 daily at end of day

S&P500 daily at end of day

End of Day Update

MARKET BEHAVIOR
The S&P500 surged to new highs, decisively breaking the 1,900 barrier.  Volume was below average, but above last week’s lethargic pre-holiday levels.

MARKET SENTIMENT
Either this is the start of the next rally leg, or one last gasp before demand dries up and we slip into the traditional summer doldrums.  Today’s breakout was largely derived from European strength following expectations of more monetary easing by the European Central Bank.  While easy money is drying up in this hemisphere, the party continues on the other side of the globe.  In reality, this is a half-empty/half-full development.  Markets are addicted to cheap money, but central bankers reliance on stimulus shows these experts don’t have confidence in the underlying economic fundamentals.

Supply and demand wise, lighter holiday volumes make it easier for smaller trades to move the market.  Today we broke through well-defined technical levels, causing many traders to buy the breakout and/or cover their shorts.  Every other time we approached these levels, demand dried up as few buyers were willing to chase these prices.  Will this time be any different?

Market rallies are built on stocks recovering from oversold levels following a bout of irrational pessimism, or they coast higher on complacency and the assumption good times will continue indefinitely.  Its been a long time since trade was dominated by fear and pessimism, meanings this strength comes from the assumption of good things to come.  The best trading opportunities come from going against the herd.  If the herd believes we have nothing to worry about, then we should be worried.  Expectations of clear sailing mean most are fully invested and the lack of fear means there is ample capacity for a wave of panic to take hold.

TRADING OPPORTUNITIES
Expected Outcome: At the upper end of a summer trading range.
Big money managers often take time off in the summer and the junior associates rarely have the authority to initiate new positions.  This lack of demand is why summer volumes are often light and we typically trade sideways.  With so many managers dreaming of the beach, it seems unlikely they will chase this market, especially since we are mostly flat for the year and there is no pressure to keep up.

Alternate Outcome:
Traders have an intrinsic fear of heights and while they are not fretting over headlines, these record highs make them nervous.  That reluctance to own makes the market under owned and will be the catalyst for the second half of the year rally.

Trading Plan:
Buying breakouts and selling weakness has been the surest way to financial ruin in this choppy, sideways market and so far we haven’t seen anything to suggest this breakout will turn out any different.  Until proven otherwise, buy weakness and sell strength.

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.