Buy the Breakout, or Settle into the Trading Range

By Jani Ziedins | End of Day Analysis

Dec 06

screen-shot-2016-12-06-at-7-29-48-pmEnd of Day Analysis

The S&P 500 added modest gains Tuesday, extending Monday’s rebound for a second day. That leaves us a couple of points from all-time highs. Volume was average, but not bad for this lull between Thanksgiving and Christmas.

In last Wednesday’s free blog post, I warned readers to be wary of the market’s pathetic afternoon fizzles.

“Today’s bullish news was more than enough to unleash a flood of buying when we opened near record highs. If the market was a coiled spring ready to explode higher, this would have triggered that move. Instead we hit our head on the ceiling and fell into tail-spin. There are few things more ominous than a market that cannot rally on good news because it tells us we are running out of new buyers.”

“Don’t get me wrong, not ready to call the bull market dead, but this week’s poor price-action says we are not ready to extend the breakout into record highs just yet. The market was getting a tad frothy following the straight-up move from the November lows. A step-back here would be a healthy part of building a sustainable foundation for the next leg higher. A high-volume dip to 2,180 would flush a lot of excess enthusiasm from the market. If prices bounce and reclaim 2,200 not long after, that tells us bulls are still in control.”

And that is exactly what happened.

While it was nice to call that move, attaboys don’t pay the bills. The more pressing question is what happens now that we returned to all-time highs. Do we resume the prior uptrend, or are we getting sucked into another sideways trading range? This is a critical distinction because it is the difference between buying the breakout, or selling the top of a trading range.

If last week’s selloff was driven by bad news and we recovered those losses this quickly, that would be a strong buy signal. Shrugging off bad news so easily tells us the market is ready to fly. But that’s not what happened. In fact the opposite happened. We fizzled on bullish news. Private payroll numbers were strong and oil prices popped when OPEC finally agreed to production caps. Even though everyone was cheering the news, the market couldn’t make any more headway because everyone was already fully invested. Unfortunately it takes more than a two-day dip to fix supply-and-demand problems like that. Tuesday’s smaller gains suggest this week’s rebound is slowing down, not getting ready to take flight.

That said, we need to be careful we don’t read too much into what could be an innocent gyration. Was last week’s fizzle telling us the November rally is running out of steam? Or was it a normal step-back on our way higher. Lucky for us the market will give us the answer over the next couple of days. If we hit our head again, supply is a serious problem and we will trade sideways into year-end. On the other hand, if we break 2,220 and don’t look back, last week was little more than an anomaly and the chase higher into year-end is on. Trade accordingly.

Last week’s fizzle makes it feel like we are falling into a trading range to close the year and is how I’m positioned, but the trader in me hopes we resume the breakout because it is more profitable to ride a wave higher.

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.

tom o'boyle December 7, 2016

Thanks for these free market updates. I’ve been impressed.
Best,
Tom O’boyle

    Jani Ziedins December 7, 2016

    I’m glad you find the posts useful.

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