Who Bought the Dip?

S&P500 daily

End of Day Update:

Wednesday produced the second 1.5% up-day this week as the S&P500 launched through 200dma resistance. The headline catalyst was Fed releasing their monthly meeting minutes. While the crowd assumed the market needs never ending easy money to keep this rally rolling, today we surged on the strongest hints yet of an imminent rate hike. Has the market lost its mind? Or is the crowd looking at this the wrong way?

Something that trips up a lot of traders is they assume there must be a reason behind every price move. Why did we drop last week? What made us go up today? The financial media lives off of this hunger for explanations. And just like everyone else in the market, rather than admit they don’t know the answer, journalists will gladly make something up. We expect them to give us reasons, not say “I don’t know”. They claim we rallied today because of the Fed meeting minutes. Had we sold off instead, no doubt they would have just as effortlessly spun the same data into a bearish tale. I’m not being critical of journalists because they are giving us what we ask of them. Filling our needs isn’t their fault. The problem lies with us and always needing a reason.

Armed with this “information”, traders further compound the problem by assuming every small move is the start of something larger. We like to draw long trend lines from small data sets. Last week’s 90-point pullback was the start of a 300-point plunge through 2015’s lows. At least that is what it felt like Friday. But that’s not what happened. Instead we find ourselves up nearly 70-points and the week is barely half over. What happened?

Everyone knows markets go up and down. They know we take a step-back for every two-steps forward. We all know it is better to buy stocks when they are cheap and sell them when they are expensive. Anyone can look at the middle of a chart and identify the obvious tops and buy-points. But once our eyes drift to the far right edge of the page, we forget everything we know. All of a sudden a very routine and buyable dip transforms into a terrifying cliff. Or a big runup feels like safe and comfortable place to buy instead of a what it really is, the last chance to take cover before the storm.

While I had no idea what the headlines would be, in my November 5th blog post I warned readers that we were setting up for a very normal and healthy pullback following a 200-point rebound from the October lows. Then in my November 12th blog post I said this was the pullback we were waiting for so instead of run scared, take advantage of the discounts. After the fact these seem like brilliant calls, but that is grossly overstating the amount of brain power it takes to see these moves for what they are, simple swings in supply and demand. We sell when the crowd is buying and buy when the crowd is selling. It doesn’t get much easier than that. Rather than get freaked out by the headlines and the far right edge of the chart, remember what you already know. It only takes a moment to find the obvious answer if we clear our mind of all the noise.

Jani

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