The Trend Is Red

 | Jan 27, 2014 | 4:30 PM EST
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Have human emotions finally trumped computer-driven algos?

The dip-buyers tried a bounce but the buying fizzled in the final hours and the Dow closed red for the fifth straight day. The weak finish is another example of how the market is now reflecting human emotions over the computer-driven algorithms that drove the action last year.

The good news is that dip-buying kicked in and the indices closed off the intraday lows, but for a market that is down as much as this one is, it wasn't a very energetic bounce attempt. Breadth was solidly negative with just 1,400 gainers to 4,300 losers and the only group that finished in the green was solar energy.

One positive spin is that this action has helped to cut the bullish bias that was downright frothy a week or so ago. There was hardly a bear to be found, but now there are doubts and worries and that is what we need to establish new support.

It has been such a long time since we have seen downside momentum of any consequence that it is difficult to recall how much damage it can do if you haven't been defensive. The losses add up very quickly and it is very easy to be frozen into inaction. Sometimes it's a good idea to make a sale or two just to break the inertia.

The market is now in a downtrend and the burden of proof lies with the bulls. They did a very poor bouncing job today and that is going to embolden the bears and drive more bulls to look for exit points.

Earnings from Apple (AAPL) may have some impact on the broader market, but it's going to take a spectacular report for it to regain its luster.

Have a good evening. I'll see you tomorrow.

Jan. 27, 2014 | 1:54 PM EST

The Action Has Changed

  • For aggressive traders seeking an edge, it is welcome.

The bad news is that the market continues to act very poorly and is unable to produce a decent bounce. The good news is that this action indicates that the artificiality that drove the market for so long may be over.

In 2013 we had gains approaching 30% with no meaningful corrections. For the buy-and-hold investor, this was ideal action. Things just went up day after day and punished all those clever market-timers who kept looking for market tops. This lopsided action produced one of the poorest years of relative performance for hedge funds; they simply could not gain any appreciable edge with an active trading approach. It was all upside with no downside.

I'm not going to go into the reasons the market was so lopsided for so long. Even casual market observers would say that the market was manipulated and didn't reflect reality. Ironically, the constant strength probably prevented individual investors from returning to the market as they felt it was a rigged game and they had no edge.

It is possible that this current correction will turn out to be just a brief interruption before we return to the pattern we saw last year, but the action in 2014 indicates that something is changing. We have had very little upside momentum, there has been a return to individual stock-picking and now we are seeing downside momentum for the first time in a while.

Many market players would definitely prefer action like 2013, but for the aggressive trader seeking an edge, this action is a welcome change. We can actually benefit from trading rather than complain constantly about selling too early.

I'm not happy with the way I've played this pullback, but the movement does make me optimistic that the reign of the buy-and-hold approach is over and that good trading will now be rewarded the way it was in the days before the Great Recession.

Jan. 27, 2014 | 10:25 AM EST

The Action Is Unconvincing

  • Should we buy a bounce or lighten up into strength?

The action is tentative and breadth is close to flat but there are signs of underlying support. The dip-buyers aren't very aggressive so far, but they have a tendency to start slowly and pick up steam the longer the market holds.

In the "old days," before to the Great Recession, an oversold bounce after the damage suffered last week wouldn't be trusted to last long but, as I've discussed hundreds of times in the last few years, the tendency of the market now is to make V-shaped moves on lighter volume. It doesn't make much sense from a psychological standpoint, but quantitative easing has pretty much undermined typical human emotions.

The issue now is whether the power of the Fed will still be felt, although they are now tapering their bond buying. A number of commentators blamed last week's downward market action on that shift, but I'm not so sure that really was the driving force.

The big question is do we buy a bounce or do we lighten up into strength. It is tough not to think that a failed bounce could develop, especially since so many are counting on going straight back up.

I'm not doing too much so far. Himax (HIMX), which I mentioned Friday, is my biggest position and I cut that back a bit into strength. The solars are finally bouncing and I'm looking to add to positions if I can in Trina Solar (TSL), Real Goods Solar (RSOL), JinkoSolar (JKS) and Canadian Solar (CSIQ). Super Micro Computer (SMCI) is a small-cap just had a very good report and that is on my radar, too.

This action is not very convincing and if we take out the intraday lows it is going to scare some dip-buyers. I'm keeping all buys very small and I'm prepared to average in over time. I suspect the market is going to continue struggling.

Jan. 27, 2014 | 7:29 AM EST

The Market's Character Has Shifted

  • We can't depend on the V-shaped bounce to bail us out.

I can't change the direction of the wind, but I can adjust my sails to always reach my destination.--Jimmy Dean

The market suffered its worst performance last week since November 2011. After the one-way action we had for most of 2013, many market players have forgotten what a correction feels like. They were not mentally prepared to deal with this sort of market shift, which made it much worse.

The bigger question now is whether this is the start of major change in market character, or just a temporary aberration that will be quickly forgotten like so many other pullbacks we've seen in the last few years. It really is quite remarkable that we have to look back over two years to find a week as bad as the one we just suffered.

What makes this recent sell-off so dangerous is that sentiment has been extremely bullish and many market players are looking for the market to snap back quickly. If we don't see a quick turn there are plenty of heavily-invested bulls who will find themselves trapped. They may help to accelerate the down-trending action as they look for a way to escape and dump stocks indiscriminately.

This market over the past couple years has consistently punished prudent traders who took defensive action as soon as there was a sign of trouble. It was very easy to feel foolish about being pessimistic when the market would immediately reverse and go back up after a couple days of selling pressure. What was even worse was that we not only bounced, but we would go straight back up as if nothing at all had happened.

The V-shaped bounces have been one of the defining characteristics of the market ever since we bottomed back in March of 2009. It has become the new normal and you have had to disregard traditional technical analysis in order to play them effectively.

Many market commentators believe that the V-shaped moves have been a product of the Fed's quantitative easing program, coupled with a higher level of computerized trading. The cash supplied by the Fed has been put to work by the computers and helped to produce a constantly-levitating market that no longer acted as if human emotion is involved.

Since the Fed announced it is starting to taper its bond buying, the market has been acting quite different. Action in 2014 has been nothing like 2013 so far. The indices are down on the year and have not had any sustained upside momentum. We have had good action in many individual stocks and have enjoyed some good stock picking, but the market simply is not acting like it did when quantitative easing was growing.

The key point here is that the character of the market has shifted. It is probably due in part to the Fed and probably due to a number of other factors as well but the proof is in the price action. We no longer have this lopsided movement and we can no longer be confident that we will see a V-shaped move to bail us out.

There is little choice but to be defensive and to finally give the bears the benefit of the doubt. Downside momentum is a rare thing in the last few years but it should be clear that we need to take steps to protect capital just in case this time it really is different.

Overseas markets were hit hard overnight as they played catch up with the poor action in the US on Friday afternoon. We have some minor bounce action but buyers are tentative and it is going to be hard to trust a bounce to last. Shorting or selling into bounce has not worked well in recent years but it is more likely to be a consideration now.

We have Apple (AAPL) reporting tonight and hundreds of other earnings reports rolling in that may help to shift the focus a bit to individual stocks. But we also have the Fed announcing its policy decision and the likelihood of more tapering to add another level of complexity.

Buckle on your trading helmet and adjust your goggles. It's going to be a bumpy ride.

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