Tuesday the S&P500 stumbled modestly following last week’s shocking rebound that recovered nearly all of the Brexit losses. We lost 100-points in the two-days after the Brexit, but bounced back over the successive three-days as if nothing happened. That dramatic whipsaw leaves most traders confused and wondering what comes next.
It is fairly obvious why the market sold off after the widely unexpected Brexit vote shocked the world, but even more unexpected was the powerful recovery that pushed us back near all-time highs. If the world is falling apart, shouldn’t the market be reeling? While that was the initial reaction, it didn’t take long for opportunistic traders to realize central banks would respond to this political calamity by pumping even more stimulus into the economy. Any talk of rate hikes was quickly replaced by reassurances of further easy money. It seems market thinks this medicine is more attractive than the Brexit is bad.
But the above analysis assumes all of last week’s buying was thoughtful and rational. While it would reassuring to think that’s the case, the size and speed of the rebound reeks of emotional, reactive, and desperate buying. Anyone who sold or shorted the Brexit headlines quickly came to regret that decision and was forced to rush back into the market. Shorts were squeezed and the imminent close of the second quarter forced money managers to buy back their books ahead of their quarterly reporting. They certainly didn’t want to be the guy who had to explain to investors why they reactively sold at the exact wrong moment. Further proof of this quarter-end phenomena is the frenzied buying ended on the last day of the quarter and July’s prices have been floundering without fresh buyers. Given the way overnight futures are trading, it doesn’t look like things will get any better Wednesday.
None of this should come as a surprise to experienced traders. One-hundred point moves over three-days are clearly not sustainable and bound to run out of steam at any second. Tuesday seemed to be that day for this rebound. Now that we stumbled back under the widely followed and psychologically critical 2,100 level, expect profit-taking and defensive selling to continue replacing last week’s reactive buying. I don’t foresee this turning into a big crash, just a bit of consolidation following last week’s dramatic swings. Two-steps forward, one-step back. Nothing unusual about that.
I shared the following analysis with subscribers early Friday afternoon when the market was up, but the momentum was stalling:
“the time to buy the dip was earlier in the week, not now that we’ve raced 100-points in three-days. If anything, I’m more interested in shorting this strength because over the near-term, moves like these are not sustainable. Most of the short-squeezing and chasing has already happened. Any bear who had a reasonable stop-loss has been chased off by this relentless climb higher. And this afternoon we are running out of momentum as we struggle to find new buyers at the upper end of the Spring’s trading range.
I have zero interest in buying the market after we’ve run this far. But a short here could be interesting. Not because I’m bearish this economic environment, but because we priced in an awful lot of optimism the last few days. Invariably sentiment will swing the other way when someone important says the wrong thing. The long-three day weekend means there is even more time for us to stub our toe.”
Looking forward to Wednesday and how to trade this, we tested and held 2,080 support and the 50dma Tuesday. Unfortunately these things are rarely one-day events and if overnight futures accurately predict tomorrow’s open, we will find ourselves slipping under this first line of technical defense. From there the next key level is 2,050 and expect at least temporary support. If we trade sideways in this area for a couple of days, that counts as our step-back and things start looking more optimistic. But if we cannot hold this level, expect another wave of defensive selling to swamp the market and the next stop is the 200dma near 2,025.
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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.