How to trade this dip

By Jani Ziedins | End of Day Analysis

May 03

Screen Shot 2016-05-03 at 8.06.40 PMEnd of Day Update:

The S&P 500 continues searching for stable footing following last week’s selloff. Thursday Japan took us down. Today it was China. What’s next? Only time will tell. While no one can reliably predict headlines, lucky for us we don’t need to know the headlines to successfully trade the market.

While I was just as oblivious to the Bank of Japan’s (lack of) response to deflation as the rest of us, I recognized the market was overheated following the sharp rebound from February’s lows and setting up for a pullback. Even though I didn’t know what the headline would be, I knew one was coming that would push us lower. How? Easy, there are hundreds of data points every day. Some are bullish and others are bearish. While the financial media always has an elegant explanation for every market gyration, the truth is the market is doing what it wants to do and the justifications only come after the fact. When people want to sell, they will always find a reason to sell. When they want to buy, they will come up with an excuse to buy. The reasons matter far less than the actions.

Now that we’ve cooled off a little, the million dollar question is if it’s been enough. While it was nice to see the S&P 500 bounce off of its late-morning lows, I’m less convinced because we didn’t undercut Thursday’s intraday lows. It was a little too easy to hold the dip, meaning we haven’t reached the point of maximum pain yet. Volume was barely average, telling us not a lot of people were reacting to these headlines and price-action. To find a real capitulation, we have to send fear through the heart of the market.

The most interesting move here would be falling through 2,040 on the heaviest volume in weeks in a multi-hour selloff that undercuts most stop-losses and convinces emotional traders to jump out before things get worse. But once that wave of selling washes over the market, supply dries up and we rebound into the close. That would be our signal to buy the dip. While that is the ideal buy-setup, unfortunately the market rarely gives us exactly what we want. If we hold 2,050 for a couple more days, that is demonstrating decent support and this becomes a valid entry point. On the other hand if we crash through 2,040 and keep on going, stay away and wait for the next level of support before even contemplating a buy.

Jani

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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.