Oct 24

Remember, dips are normal and healthy

By Jani Ziedins | End of Day Analysis

End of Day Update:

On Tuesday the S&P500 tried to recover Monday’s selloff, unfortunately the follow through never materialized and we finished well off the intraday highs. Traders still seemed more inclined to take profits than buy the dip.

If this market was poised to rip higher, this was the bulls’ opportunity. The lackluster buying suggests this weakness will likely extend past Monday’s dip. But this isn’t a bad thing. The recent runup leaves us 70-points above the 50dma and a check back is long overdue. The only question is if we dip back down to this key moving average, or trade sideways and allow it to catch up.

Falls from unsustainable levels typically happen quickly, so the longer we hold current levels, the more likely a sideways consolidation becomes. But we need a few more days because two-days definitely doesn’t qualify as solid support.

Last Friday we broke out to record highs when the Senate finally agreed on a budget. That clears the way for more significant Tax Reform. Unfortunately those fuzzy feelings didn’t last long and rifts within the Republican party started showing as Trump and key Senators started throwing barbs at each other. Trump definitely has a more antagonistic leadership style and that will likely lead to more tension during the Tax Reform debate. The market hates uncertainty and this conflict will likely erase a big chunk of the hope that lifted us to these levels.

I’m most definitely not a bear and still think the path of least resistance over the medium-term is higher. But I have also been doing this long enough to know the market doesn’t move in straight lines. After a period of nice gains, it is perfectly normal for the market to consolidate the runup. This is part of the healthy process of moving higher. In fact I would be more concerned about the sustainability of this rally if we didn’t consolidate recent gains. The higher we go, the harder we fall when the inevitable consolidation eventually happens.

All of this means this is definitely a better place to be taking profits than initiating new positions. But just like how we shouldn’t overreact to recent strength, the same level-headed thinking will be required if we dip further over the next several days. Additional weakness is creating a buying opportunity, not an excuse to reactively abandon an otherwise healthy market. Remember, smart money trades proactively by selling strength and buying weakness. Reactive traders bleed themselves dry by doing the opposite they buy high and sell low. Don’t be a reactive trader.

Jani

Oct 22

Weekly Scorecard: History is not on the Bull’s side

By Jani Ziedins | Scorecard

Welcome to Cracked.Market’s weekly scorecard:

This post includes a summary of the week’s market developments, links to the free posts I published, and analysis on how accurate each post was since I wrote it. 

Weekly Analysis

It was another strong week for the S&P500. This was the sixth consecutive weekly gain and the eighth out of the last nine. For historical perspective, only one other stretch since Trump’s election strung together six up-weeks. Unfortunately the next week started a 70-point pullback. The question on everyone’s mind is, “How many more weeks can this keep going?”

The attached chart shows the market’s waves over the last 12-months. Five periods of up followed by sideways and/or down. When prices dipped to the 50dma, the consolidation tended to be brief. The times we didn’t dip, the market traded sideways until the moving average caught up before staging the next leg higher.

Currently we are approximately 80-points above the 50dma. Early in the rally we found ourselves as high as 100-points above the 50dma before peaking. Other times we stalled 40-points above the 50dma.  80-points is definitely on the higher end of the range, but not the most extreme and it is possible we could go a little higher. But it would break precedent if we went a lot higher.

Bulls are definitely getting cocky and my last few posts generated a fair bit of criticism when I suggested this was a better place to be taking profits than adding new positions. But this is actually a good thing and I find their criticism reassuring because I get nervous when too many people agree with me. Without a doubt momentum can keep this rally going for a few more days or weeks, but history tells us we are definitely close to the end of this ride. Famous last words often start with, “This time is different.”

And to be clear, I’m not bearish nor am I predicting a crash. The 50dma is a little too far away and we either need to pause and let it catch up, or we dip back down to it. Nothing more, nothing less.

October 19th: Why smart money will sell the Senate’s budget

If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.

 

There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.

 

That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.

 

There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.

 

There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.

Score To Be Determined: We won’t know how accurate this analysis is for several weeks, but I haven’t seen Congress pass meaningful legislation without relentless bickering and infighting. And that is a normal Congress. This group of Republicans is even more fractured and divided than normal. I would be shocked if Tax Reform progresses smoothly and we should be prepared for the volatility this heated debate will trigger.

October 17th: Why bulls need to be careful

For those of us that are paying attention, this looks a lot like a lethargic wedge higher and suggests this market is running out of gas, not on the verge of exploding higher. Explosive moves are by definition explosive. A tiny trigger blossoms into in a much larger move. Sometimes it is an unexpected headline, other times a technical breakout. But something triggers a surge of buying and away we go.

 

Unfortunately this wedge higher is the opposite of explosive. We keep getting good news. Today the Trump administration said they wouldn’t put conditions on repatriated profits and companies could use their newly liberated cash for dividends and buybacks. More cash in shareholders’ pockets is always a good thing. Then there was the technical the breakout as we moved into record territory. The cumulative result of both of these bullish developments, a measly 0.07% gain. Something so small it doesn’t even qualify as a rounding error.

 

Every day bulls are trying to push us higher, but the gains are getting smaller and smaller. That reeks of exhaustion, not unbridled potential. Without a doubt it is encouraging we managed to hold recent gains. Typically markets tumble from unsustainable levels quickly. This strength comes from owners who are confidently holding for higher prices and few are taking profits. Their conviction keeps supply tight and props up prices. Unfortunately propping appears to be the best bulls can manage. We need new buyers to keep this rally going and right now those with cash are reluctant to chase prices any higher.

Score 7/10: The market popped 0.5% Friday following the Senate passing a budget. By itself this event doesn’t mean a lot, but it brings us one step closer to Tax Reform. I still believe this will be a bumpy road, but any progress is good. The market is up 15-points from when I wrote this post so I docked myself a few points, but I still think the analysis is valid. The true test will come next week when we either extend Friday’s gains, or that breakout fizzles and we slip back to 2,550. Most likely prices fizzle, but there is a chance a frenzy of buying sends us dramatically higher. But the higher we go without consolidating gains, the harder we fall when it finally happens.

Cracked.Market University

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CMU: Why most traders screw up counter-trend trades

Counter-trend trades are one of the hardest ways to make money.That’s because traders fight an uphill battle and their timing needs to be flawless, otherwise they get run over. Despite these overwhelming odds, all too often traders cannot resist the temptation to argue with the market. In this post I will help you understand why counter-trend trading is so difficult, when it is okay to go against the trend, and the risks you face when doing it. Knowledge is power and the more you know going in, the better chances you have of coming out the other side alive, and maybe even with a little extra money in your pocket.

CMU: Are You a Victim of Beginner’s Luck?

Unfortunately beginner’s luck is not sustainable and all too often trader’s mistakenly believe their early good fortune was due to skill, not luck. Rather than dig in and learn from more experienced traders, they assume they have this game figured out and don’t need any help. Their early success convinced them they already know everything they need to know. Only after they lose their first stake do they start looking for outside guidance.

 

If you are reading this, most likely you experienced some early success and that encouraged you to keep at it. But now things have gotten harder and losses are more common than profits. While it hurts, realizing trading is not easy is actually a good thing. And if you figured this out early, count yourself lucky. Traders who experiences too much early success keep upping the size of their trades until inevitable fall goes from emotionally demoralizing, to financially ruinous.

Knowing what the market is going to do is the easy part. Getting the timing right is where all the money is made. Have insightful analysis like this delivered to your inbox every day during market hours while there is still time to act on it. Sign up for a free two-week trial.

Have a great weekend and I hope to see you again next week.

Jani

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Oct 19

Why smart money will sell the Senate’s budget

By Jani Ziedins | End of Day Analysis

End of Day Analysis:

The S&P500 fell out of bed Thursday morning when it started the day with the biggest losses in over a month. But within an hour supply dried up and dip buyers rushed to our rescue. Not only did we finish off the early lows, we actually managed to close in the green. That said, volume was unremarkable given how dramatic the price-action was.

This was an impressive reversal and it leaves us wondering what it means. Decisive reversals are often strong buy signals when they follow multi-day selloffs and the rebound occurs following yet another piece of bad news. Selling capitulates when then the crowd is most uncertain and fearful. That is when the last of the nervous sellers bail out and moments later prices rebound when there is no one left to sell. Unfortunately that setup looks nothing like today’s dip and rebound.

Things got more interesting late Thursday evening when the Senate passed a budget. While it was nice to finally see something not crash and burn in the Senate, the budget is largely a procedural matter and really doesn’t count for anything. The only significant thing is it allows Republicans to avoid a Democrat filibuster when voting on their yet to be announced Tax Reform Bill. Overnight futures popped 0.3% on the encouraging developments.

So what is a trader to do on Friday? Thursday’s intraday rebound appears constructive. Then you have the good news coming out of the Senate. Most likely the best plan is to sell the news. There are a couple of reasons why.

The easiest to explain is politics. If anyone believes our leaders will have constructive dialogues, quickly arrive at consensus, and pass a great Tax Reform Bill clearly isn’t paying attention. Politics is messy and I have no doubt Tax Reform will stumble countless times before it has a chance of passing.

There are two key rules every politician learns when they get to Washington:
A) Throw a fit until you get what you want.
B) If you don’t get what you want, blow everything up.

That is how Healthcare Reform went down and if anyone thinks Tax Reform will be any different, there is a medical term for that, it’s called insanity.

There are several opposing forces in the Republican party that will make any compromise difficult. First are the pro-business Republicans who want aggressive business tax cuts to stimulate growth. Second are the fiscal conservatives who bristle at the thought of adding to the deficit. And third are the moderates who want to see most of the tax cuts benefit the middle class. Three very different factions whose ideas are in direct conflict with each other. Without a doubt we will see someone throw a fit and refuse to support the first draft of the bill. Get three of those someones and the whole thing goes down in flames.

There is a good chance a compromise will eventually be reached, but politics is ugly and most likely this process will teeter on the verge of collapse moments before it is salvaged at the last possible second. Expect a lot of bad news between now and then.

Next comes the market’s price-action. As I’ve been writing about for the last two-weeks, the market is extended and needs to consolidate recent gains. Everyone knows markets move in waves and we are near the upper end of the latest wave. I’m definitely not predicting a crash, but catching our breath is a normal and healthy thing to do following a 100-point move from last month’s lows.

The market is fatigued and this is easily seen in the lethargic breakouts to record highs. Gains of 0.18%, 0.07%, 0.07%, and 0.03% over the previous four days show how little interest there is in buying the record highs. If there was explosive upside left in this rally, we would have raced higher by now. Instead these insignificant “breakouts” tell us demand is drying up.

Don’t get me wrong, I’m not bearish, just realistically cautious. Consolidations are a normal and healthy part of moving higher. The quickest way to refresh a market is pulling back to support. The longer way is drifting sideways for an extended period and allowing the trend lines and moving averages to catch up. Either one will work for this market and only time will tell which one we get.

I’m most definitely not calling a top here, just warning that the upside is more limited than the downside. Long-term investors should stick with their favorite positions, but shorter-term traders need to think about locking-in profits and waiting for better prices.

Jani

Oct 18

CMU: Why most traders screw up counter-trend trades

By Jani Ziedins | Free CMU

Cracked.Market University

Counter-trend trades are one of the hardest ways to make money.That’s because traders fight an uphill battle and their timing needs to be flawless, otherwise they get run over. Despite these overwhelming odds, all too often traders cannot resist the temptation to argue with the market. In this post I will help you understand why counter-trend trading is so difficult, when it is okay to go against the trend, and the risks you face when doing it. Knowledge is power and the more you know going in, the better chances you have of coming out the other side alive, and maybe even with a little extra money in your pocket.

As I wrote in a previous educational post, most traders don’t understand contrarian investing. Too many people mistakenly believe contrarian trading is going against the trend. Nope, the trend has nothing to do with it. Contrarians go against the crowd, not the trend. Big, big difference and if you are a little unsure, check out my previous post.

There is nothing wrong with a stock or index that goes up. That’s how the S&P500 went from 100 to 200, 500 to 1,000, and why we currently find ourselves above 2,500. If an investor knows nothing else, smart money bets on the market going higher because that is what it does. Blame inflation, productivity, money printing, or anything else, it doesn’t really matter. Markets go up more than they go down and that’s all that matters to the long-term investor.

But we’re traders and we want to trade. We don’t want to sit idly through every gyration. Not only do we want to skip the next pullback, we want to profit from it by shorting the decline. Everyone knows markets go down, especially after it goes up “too much”.  Unfortunately that overly simple logic costs a lot of smart people a lot of money.

Markets move in waves and I cover this another educational post, but suffice to say every bit of up is followed by a normal and healthy bit of down. Trading these waves is not a bad thing as long as we keep selling high and buying low. Unfortunately that is a lot easier to say than it is to do.

For beginners, the best way to swing-trade is to ride the wave up, sell when after a nice run, and then wait to buy the next dip. This way you are always trading alongside the trend. If you buy a little too early or late, it doesn’t really matter because mistakes are fixed by waiting it out. Did the market keep going down after you bought the dip? No problem, just wait for the rebound to erase your losses. Hold a little too long and the market fell under your buy point?  No worries, simply wait for the next wave higher.

Counter-trend traders don’t have these same protections. If they screw up and don’t exit immediately, the losses only get bigger as the market marches away from them. Short an uptrend at the at the wrong time and the more stubborn you are, the more money you lose.

I will be honest, I short bull markets. But I also acknowledge this is a low-probability trade and am doing it more for entertainment than to make money. But as long as I pick the right entry point, the risks are manageable.

The key to surviving counter-trend trades is to assume a trend will continue and it requires proactive timing. Short a move to the top of the range, not a violation of the lower end. As I said earlier, markets move in waves and the best short opportunities are when everyone is fat and happy. By the time traders are nervous and the headlines dire, it is too late. At that point a smart traders is thinking about buying the dip, not shorting the weakness. And when counter-trend trades show a profit, get paranoid of a rebound and start looking for an excuse to cash-in.

Remember trends continue countless times, but they reverse only once. The odds always favor a continuation of the previous trend and smart traders stick with the high probability trade.

There are ways to identify a trend that is dying and about to reverse. That sounds like an excellent topic for another blog post! Signup for Free Email Alerts so you don’t miss it.

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Oct 17

Why bulls need to be careful

By Jani Ziedins | End of Day Analysis

End of Day Update:

The S&P500 closed at yet another record high on Tuesday. Never mind the fact we only moved 0.07% above Monday’s record close, which was up only 0.18% from Friday’s close. Records are records and today counts…right?

For those of us that are paying attention, this looks a lot like a lethargic wedge higher and suggests this market is running out of gas, not on the verge of exploding higher. Explosive moves are by definition explosive. A tiny trigger blossoms into in a much larger move. Sometimes it is an unexpected headline, other times a technical breakout. But something triggers a surge of buying and away we go.

Unfortunately this wedge higher is the opposite of explosive. We keep getting good news. Today the Trump administration said they wouldn’t put conditions on repatriated profits and companies could use their newly liberated cash for dividends and buybacks. More cash in shareholders’ pockets is always a good thing. Then there was the technical the breakout as we moved into record territory. The cumulative result of both of these bullish developments, a measly 0.07% gain. Something so small it doesn’t even qualify as a rounding error.

Every day bulls are trying to push us higher, but the gains are getting smaller and smaller. That reeks of exhaustion, not unbridled potential. Without a doubt it is encouraging we managed to hold recent gains. Typically markets tumble from unsustainable levels quickly. This strength comes from owners who are confidently holding for higher prices and few are taking profits. Their conviction keeps supply tight and props up prices. Unfortunately propping appears to be the best bulls can manage. We need new buyers to keep this rally going and right now those with cash are reluctant to chase prices any higher.

Everyone knows the market moves in waves and it is obvious from the chart this market is at the upper end of its range. I still believe in this bull market and am most definitely not a perma-bear predicting a crash. But I recognize when the market gets ahead of itself and needs to consolidate recent gains. Without a doubt we reached a point where we need to cool off.

The quickest way to consolidate recent gains is dipping back to support. That is a normal and healthy way to reset the clock and clear the way for a continuation higher. The slower route is trading sideways for a longer period of time and allowing the trend lines and moving averages to catch up. We’re only a couple of weeks into this sideways trade and it would take several more weeks of treading water before we come close to consolidating recent gains. As a point of reference, the 50dma is still 70-points underneath us.

Strictly looking at the market dynamics, at best we trade sideways for several weeks. Worst we dip back to 2,500 support. Either way this is not a great time to be putting new money into the stock market.

If we move beyond the market and consider looming headlines, Republicans are making good progress toward tax reform. Without a doubt this encouraging news contributed to recent gains. But it doesn’t take a political science degree to know these negotiations get ugly, often to the point of crushing all hope moments before a deal is finally reached. That is standard operating procedure for Congress and we should expect more of the same here.

Republicans are currently in the brainstorming phase where everything and anything goes. But soon they will transition to the compromise stage where opposing sides and special interests dig in and threaten to blow the entire thing up if they don’t get their way. It is only time before the current feelings of hope for tax cuts devolve into cynicism. Most likely that shift in sentiment will be the catalyst that triggers a pullback to support.

Without a doubt our politicians could unexpectedly announce fair and reasonable tax reform ahead of schedule, but I certainly wouldn’t bet my money on it. Between the price-action and the headline environment, I suspect the next few weeks will be a lot more challenging for the stock market.

Buy-and-hold investors should stick with their favorite stocks, but shorter-term traders should look for opportunities to lock-in profits and the most aggressive can think about shorting. That said, the path of least resistance is still higher and any dip should be bought. This will be nothing more than a normal and healthy dip on our way higher.

Jani

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Oct 16

CMU: Are You a Victim of Beginner’s Luck?

By Jani Ziedins | Free CMU

Welcome to the new Cracked.Market University educational series. Look for new articles every Monday and Wednesday.

CMU: Are You a Victim of Beginner’s Luck?

Hang around trading circles and you inevitably hear of a phenomena called beginner’s luck. This is where a new person experiences unusually good fortune. How can a new person be more lucky than the experienced traders around him? Let’s investigate.

Statistics make a compelling argument a beginner has no better odds of success in a game of chance than someone who has been doing it for a while. Let’s simplify it to a game of betting on a coin-flip. If he predicts heads and the coin lands heads, he wins. If the coin lands tails, he loses. Simple enough.

Assuming a fair coin and toss, we would expect the outcome to be totally random for both the novice and the experienced coin-flip guesser. If there is zero ability to predict the outcome, skill has nothing to do with it and the result is down to random luck. Under these rules, a beginner and an experienced coin-flip guesser will have same level of success, on average winning half the time. Despite superstitious beliefs to the contrary, in games of chance a beginner has no more opportunity to be lucky than the experienced coin-flip guesser.

In a game of skill, you would definitely expect a more experienced participant to do better than a novice. An 18-year-old who has been playing football since he was six would most likely enjoy more success in a pickup football game than another 18-year-old foreigner who has never seen a football game.

It doesn’t take a genius to know the more you practice something, the better you get. This makes sense and no doubt applies to trading. But the skill that comes from experience implies the exact opposite of beginner’s luck. In most instances the novice will vastly underperform the experienced professional.

So where does this notion of beginner’s luck come from? Is there a way it can still be true despite these logical and compelling arguments against beginner’s luck?

The one thing we haven’t considered yet is human nature. A person who loses a lot of money in their first handful of trades will most likely quit in disgust. After losing $5k, $10k, or $20k in their first handful of trades, they will most likely come to the conclusion the market is rigged and it cannot be won. They quit and never look back.

But the opposite is true for a person who experienced early success. If a person makes $5k, $10k, or $20k on their first few trades, they think they have a knack for trading and become addicted to the thrill of winning. Without a doubt the people who experience early success are far more likely to stick with it and keep coming back. That early success will even convince traders to stick with it after a period of losses because in their heart they know they are good at this. It is only a matter of time before their cold streak ends and their luck improves.

So while it is true a beginner has no better odds of success in a game of chance, and a worse odds of success in a game of skill, beginner’s luck is still a very real phenomena in trading circles. That is because of survivor’s bias. Early losers quit and only the traders who enjoyed early success stuck around. Tha means in any groups of experienced traders, most of them started with a hot streak.

Unfortunately beginner’s luck is not sustainable and all too often trader’s mistakenly believe their early good fortune was due to skill, not luck. Rather than dig in and learn from more experienced traders, they assume they have this game figured out and don’t need any help. Their early success convinced them they already know everything they need to know. Only after they lose their first stake do they start looking for outside guidance.

If you are reading this, most likely you experienced some early success and that encouraged you to keep at it. But now things have gotten harder and losses are more common than profits. While it hurts, realizing trading is not easy is actually a good thing. And if you figured this out early, count yourself lucky. Traders who experiences too much early success keep upping the size of their trades until inevitable fall goes from emotionally demoralizing, to financially ruinous.

I’m glad you found this blog and my goal is to help other traders learn from my years of struggles and successes. No matter what the late night infomercials claim, trading is hard and it takes work. The first step is educating yourself. The second step is gaining firsthand experience by trading smaller sizes. The goal isn’t to make money, but to learn how to trade. The best way to approach the market in the beginning is viewing your account as the amount you are willing to pay in tuition. If you have $100k, start trading $20k. If you have $10k, start trading $2k. This way when you get wiped out, you have the ability learn from your mistakes and start over. Give yourself enough time to learn from your mistakes and your chances of success go way up.

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Oct 06

Weekly Scorecard: Tread lightly

By Jani Ziedins | Scorecard

Welcome to Cracked.Market’s weekly scorecard:

This post includes a summary of the week’s market developments, links to the free posts I published, and analysis on how accurate each post was since I wrote it. 

Weekly Analysis

The S&P500 surged to record highs this week, breaking through 2,550 in Thursday’s trade. But the first employment losses in seven-years dampened the mood on Friday, giving us the first down day in nearly two-weeks.

As good as things feel, we must remember markets cannot go up every day. Thursday’s gains were the eighth in a row and sixteenth out of the last nineteen. A down day was inevitable, the question is if Friday’s 0.1% dip is enough to refresh the market and set the stage for a continuation higher.

A big chunk of this week’s enthusiasm stemmed from Republicans making progress toward tax reform. That was enough to put people in a buying mood and the early strength triggered a wave of reactive breakout buying and short-covering.

The thing we have to be careful of is Republicans are still in the brainstorming phase of crafting this bill. Next they need to figure out what compromises are required to make this thing work. That is where things get difficult. Healthcare reform went well….until it didn’t. There is a good chance the same will happen here and this week’s optimism could easily turn into next week’s pessimism.

At this point I don’t think there is a lot of upside left in this move. The only question is if we pullback to support, or we consolidate recent gains by trading sideways. There is no reason to sell long-term positions to avoid a near-term dip. Shorter-term traders should be thinking about taking profits. And those with cash should resist the temptation to chase prices higher. That said, the path of least resistance is still higher and every dip is buyable.

October 3rd: Is it finally safe to buy?

Without a doubt the path of least resistance is higher, but we know markets don’t move in straight lines. We need to mix in a few down days to keep this market healthy and sustainable. When a red-day happens, don’t freak out and start calling a top. If this market was going to crash, it would have happened weeks ago when headlines and sentiment were far more dire. Instead, expect the rate of gains to slow and for the market to spend a few weeks consolidating recent gains. We can keep going up for a few more days, but the higher we go, the harder we fall during the normal and healthy down wave. But either way, this is definitely a better place to be taking profits than adding new positions. Buy-and-hold investors can keep holding, but traders with profits should start thinking about locking them in, and those with cash should resist the temptation to chase.

Score 8/10: I knew momentum could carry us higher over the next few days and that is what happened. But this is still a better place to be taking profits than buying new positions. I docked myself a couple of points because we still don’t know how this trade will turn out. If the surge higher fizzles next week, then I can boost my score. If we keep surging higher, then I will take off a few points. The important thing to keep in mind is I am not calling a top, just saying the risk/reward has shifted against us. The upside remaining above us is far less than the downside below us.

October 5th: What smart money is doing here

To be brutally honest, only and idiot would buy the eighth consecutive up-day and seventeenth out of the last twenty. As I wrote in yesterday’s free educational piece, everyone knows markets move in waves, unfortunately most forget that fact when planning their next trade. Just as I knew August’s selloff was unsustainable, I also know this surge higher is not sustainable.

Over the last two-weeks the market has been wedging higher. This is the least sustainable price pattern. The shape is formed by desperate breakout buying and short-covering. Two of the most powerful, but least sustainable forces in the market. Once these smaller groups run out of money, most of the time there is no one left to fill the void. Big money hates chasing prices higher and almost always waits for a dip. In a self-fulfilling prophecy, big money’s reluctance to chase prices creates the lack of demand that causes prices to dip.

Without a doubt we can coast higher for a few more days, but dips are a normal and healthy part of every move higher. Without periodic pullbacks, foundations are weak and prone to failure. The higher we go over the near term, the harder we fall. I am in no way predicting a market crash and I still believe in this bull market, but I know what sustainable rallies look like and this is not it. At best we trade sideways for several weeks and consolidate recent gains. Worst case is we test 2,500 support and even dip a little under it. While not a big deal for most of us, that will be a painful ride or anyone who bought these record highs.

Score 8/10: Friday was technically a down day, but 0.1% really doesn’t count following such a large rally. The lack of profit-taking tells us most owners are confidently holding for higher prices. That keeps supply tight, but supply is only half the equation. Big money tends to fear heights and their lack of buying could cause us to drift lower. But don’t expect us to fall too far. There are a lot of managers desperate to get in this market and they buy any and all dips. It is still a little early to score this week’s analysis and next week’s trade will be a lot more insightful.

Cracked.Market University

Excerpts from my new educational series. Click the title to read the full post. Signup for Free Email Alerts to be notified when news posts are published.

CMU: The obvious trade everyone screws up

The problem is most traders convince themselves every move higher or lower will continue indefinitely. When the move goes the direction of their bias, their confidence swells as the market’s price-action confirms their ideas. This confidence causes them to rush headfirst into a big position before they miss the trade they have been waiting for. Unfortunately most of the time their confidence doesn’t come until the market has already made a sizable move in the direction of their bias. In the bull’s case, when the market is making a higher-high. The problem is confidence is highest just as the last of the buyers are rushing into the market and prices are about to slip back into the trading range.

When a new trade falls into the red so quickly, confidence is shattered and replaced by uncertainty and fear. Traders initially convince themselves they can hold through a brief pullback because they are still believe they are right. When that doesn’t happen, doubt grows until vulnerable traders bail out because the pain of regret grows too strong. This selling pressures prices further, causing more nervous owners to sell, further pressuring prices. The downward spiral continues until we exhaust the supply of nervous sellers. Unfortunately for these reactive sellers, prices rebound not long after they bailout.

Knowing what the market is going to do is the easy part. Getting the timing right is where all the money is made. Have insightful analysis like this delivered to your inbox every day during market hours while there is still time to act on it. Sign up for a free two-week trial.

Have a great weekend and I hope to see you again next week.

Jani

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