What comes next?

S&P500 daily at end of day

End of Day Update:

And on the third day the market rested, giving up a fraction of a percent following a two-day, 30-point rebound.  Volume continues falling off a cliff as every day over the last five finished with less volume than the day before.  Some claim low volume is bearish, others say it is bullish.  But what we know for sure is traders are growing comfortable with their positions and simply waiting for the market to make its next move.

Wednesday is an important day.  Either we breakout and reclaim 1,950 support, or the rebound stalls and we fall back into the consolidation.  Obviously a breakout is bullish, but slipping back into the trading range is not necessarily bearish.  It could mean the market needs more time before resuming the up-trend.  But the risk is the longer we stay inside the trading range, the more vulnerable we are to slipping under 1,900 support and triggering all the technical stop-losses littered under this widely followed level.  That could kick off another round of emotion selling.  But rather than fear this, we should embrace it because it will likely form a capitulation bottom and set the stage for a sharp, and profitable, rebound.

The one warning I have bulls is rebounds from oversold conditions snap-back with ferocious force.  Trading between 1,910 and 1,940 for nearly two weeks shows the market is clearly not stretched to unsustainable levels.  Either that means we have more selling left before finally reaching extreme levels, or the market is content hanging out here and we should expect a more protracted consolidation.

If I am right:
Most of the time markets trade to extremes, meaning there is a good chance we will slip even further before this pullback is done.  Often corrections find support halfway through the move as dip-buyers rush in and prop up the market.  But if we cannot find a more diverse pool of interested buyers, demand dries up and we stumble into another leg lower.  Failing to escape from this consolidation in coming days leaves us at greater risk of one last leg lower.

If I am wrong:
It’s been a fearful couple weeks and we’ve seen quite a bit of turnover as ominous headlines scared out the weak and replaced them with confident traders willing to buy the dip.  Retaking and holding 1,950 support will show the worst is behind us, at least in the near-term.

Trading Plan:
At this point the market could go either way and we don’t have an edge in coin-flip style trades.  Bulls can stay long, bears can stay short, and those out can stay out.  But soon I expect we will get more clarity from the market as it reveals what it is thinking.  From there we can find a trade with better odds.

Jani