Why Friday’s retreat shouldn’t have surprised anyone

Free After-Hours Analysis: 

The S&P 500 spent Friday’s session bouncing between breakeven and moderate losses as it digested January’s blowout employment report before ultimately closing down 1%.

Economists were shocked by January’s robust hiring that drove unemployment to 50-year lows. Few saw this coming following several months of slowing employment gains.

As with everything in the market, there are two ways to interpret this result. The market’s knee-jerk reaction was fear the Fed will be forced to raise rates higher and keep them there longer than previously thought. Of course, the optimist will point out that slowing inflation AND robust employment is the perfect landing we’ve been hoping for.

Which is it, is good good, or is good bad? It all comes down to if a person believes strong employment will be an obstacle to containing inflation.

But even more basic than reacting to the headlines, the market consumed a huge pile of upside getting to these six-month highs, flipping the risk/reward on its head.

Risk is a function of height and common sense tells us it is safer to buy when prices are low and risker to buy when they are high. At the highest prices in half a year, no matter what the headlines are, we are vulnerable to a very normal and healthy step back. 4,200 resistance is just ahead and it isn’t a surprise to see buying cool off here, no matter what the headlines are.

While I don’t fear “too good”, I am aware that it’s been a good run and stepbacks are part of every move higher. I still like this market over the medium and long term, but the risk/reward has gotten away from us over the near term.

That’s why I told readers Thursday night I started harvesting profits:

As much as I like this market right now, it is making me nervous and that is enough for me to shift to a defensive mindset. Stocks move in waves and every two steps forward are followed by a step back. Without a doubt, stocks can continue climbing for another few days, but we take profits when everyone feels good. And right now things feel pretty darn good. We don’t need to sell everything, but it makes sense to lift our trailing stops and consider taking some partial profits. Remember, we only make money when we sell our winners.

Sign up for my FREE email alerts so you don’t miss the market’s next big move

I had no idea what was going to happen with the employment report, but when the rubber band gets stretched a little too far in one direction, the odds of a normal and routine snapback increase.

As for how to trade this, we take profits when we have them because if we hold too long, they tend to escape. As good as it felt watching profits pile up on Wednesday and Thursday, every good thing comes to an end eventually.

The older the 2022 bear market gets, the lower the volatility becomes. Six months ago, a breakout like Wednesday would have continued for five or more sessions. Today it runs out of gas in 48 hours. This is perfectly normal as traders get used to our new reality and stop overreacting to every bump in the road.

The economy remains strong, but the market tends to get ahead of itself and Thursday was a nice place to start locking in some very worthwhile profits. But as always, as soon as I’m out, I start looking for the next place to get back in. The next opportunity could arrive as early as next week.

Sign up for my FREE email alerts so you don’t miss the market’s next big move

If you find these posts useful, help me out by liking and sharing them!

Sign up for FREE Email Alerts to get profitable insights like these delivered to your inbox every evening.

What’s a good trade worth to you?
How about avoiding a loss?
For less than $1/day, receive actionable analysis and a trading plan every day during market hours

Follow Jani on Twitter @crackedmarket