Why Tuesday’s 0.1% gain is far more significant than it seems

Free After-Hours Analysis: 

The S&P 500 finished Tuesday up a measly 0.1% after bouncing off of 3,800 support earlier in the session.

That small gain was enough to snap a four-session losing streak, but such a marginal gain would normally be easy to brush off in the face of the more than 200 points of selling since last week’s intraday highs. But Tuesday’s 0.1% gain was anything but normal.

S&P 500 overnight futures crashed Monday night after the Bank of Japan surprised investors by taking a more hawkish stance and allowing bonds to move to a higher interest rate. That sent Japanese stocks down 2.5%, and it looked like Tuesday was going to be another rough session for U.S. equities.

But not long after the U.S. open, the S&P 500 bounced into the green. Funny how that works. Bad news and stocks actually rally. What’s up with that?

First, it’s been nearly a decade since anything in Japan brought down U.S. stock prices. And even more recently, U.S. equities have been immune to problems in China and Europe, so why should Japan be any different?

U.S. stocks are trading based on U.S. inflation, the U.S. economy, and U.S. Fed rate hikes. Nothing else matters to domestic stocks and it is no surprise headlines out of Japan failed to register once the main trading session opened Tuesday morning.

And Second, if 3,800 support was fragile and stocks were prone to a much larger selloff, the Japanese headlines were more than enough to break this camel’s back. Yet, instead of mirroring the international indexes, U.S. owners shrugged at the bearish headlines and kept holding.

While it is hard to get excited by a 0.1% gain, it sure beats where we were headed when Tuesday’s session opened.

Few trading signals are more powerful than a market that doesn’t do what it is supposed to do. Now, we can’t read too much into a few hours of unexpected resilience, but so far the bounce off of 3,800 looks really good and that won’t change until we fall under Tuesday’s intraday lows.

As I wrote Monday night, I closed my short positions for a very tidy profit and started to go long when the index found support at 3,800 late Monday. I added to those initial long positions when prices bounced Tuesday morning and I will add even more Wednesday if this counter-intuitive strength holds up.

I love trades where the market doesn’t do what it is supposed to be because that means the supply and demand dynamics under the surface are stronger than anything the headlines can throw at it. If the Bank of Japan can’t break this market, imagine what will happen if some good news comes along.

My stops are under Tuesday’s lows and if prices rally Wednesday, I will quickly move my stops up to my entry points, turning this into a low-risk/high-reward trade. And if this one doesn’t work, no big deal, I sell at my stops and try again the next time the market bounces.

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