Stocks exploded higher in one of the biggest up-days of the year. We received encouraging housing numbers this morning but they were certainly not enough to justify this type of pop. Instead of a fundamental driver, this rally was fueled by sentiment.
As I wrote last week, bullish sentiment fell to five-year lows. While things can always get worse, the more skewed the market gets in one direction, the more likely a swift reversal becomes. Last Thursday’s intraday dip and rebound was our signal to buy. Breaking support is an obvious trigger for additional selling, but when that wave of liquidation failed to materialize, that is when we knew the sellers weren’t there. Friday’s and Tuesday’s strong gains confirmed this thesis. We’re not going up on good news, we’re rallying on a lack of supply. No matter what the headlines, when owners don’t sell, supply tightens and prices rebound.
The cynical bear will point to Tuesday’s light volume rebound, but that is further proof most owners are not interested in selling. They’re happy with their positions and not responding to headline fear-mongering or weak price-action. Tuesday’s rebound reaffirms their decision to hold, making them even less likely to sell the next round of recycled rate-hike/China/oil/weak earnings headlines.
Given how skewed sentiment was, most likely there is more life in this rebound. The next obvious target is 2,100 resistance. From there it really becomes a battle of wills between those with cash and those with stock. Every previous rally attempt was thwarted when those with cash were unwilling to chase a breakout. Since we are quickly approaching the summer doldrums, we shouldn’t expect anything different this time. With big money managers headed to the Hamptons, a lot of institutional money will be on autopilot over the next few months. That means a continuation of this this sideways chop. Until further notice, buy weakness and sell strength.
For a trading plan, as long as the market continues to behave well, dip-buyers should hold until we test 2,100 resistance. Breaking this level could lead to another round of chasing and short-covering. If the breakout fizzles, that will be our signal to take profits. On the downside, take profits defensively if we stumble back under the 50dma this week. A deflation similar to May 11th tells us there is no demand and we need to lock-in profits before they evaporate.
What’s a good trade worth to you? How about avoiding a loss?
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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.