Don't Underestimate Underinvested Bulls

 | Jul 09, 2014 | 4:15 PM EDT
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After two days of selling, the market managed a bit of a bounce, but it wasn't very energetic. Volume was lighter, small-caps were flat and precious metals were hot. You'd expect this sort of bounce within a rollover, but plenty of bears have been fooled by this behavior in the last couple of years.

This market has consistently run back up on lower volume following pullbacks. That is one of the reasons the market has had so many underinvested bulls. They never manage to put much money back to work because the bounces don't look very trustworthy.

The most interesting thing today was the favorable reaction to the minutes of the FOMC, despite the comment that the QE program would end in October. That isn't a big surprise, but it isn't something that would typically generate a positive reaction. It is likely that some computer algorithm helped goose the market.

As I mentioned earlier, the pattern in March after a similar selloff in momentum and small-cap stocks was a three-day bounce before rolling over again. The bulls will likely be looking for more upside tomorrow, and I wouldn't be in a rush to fade them.

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

July 09, 2014 | 1:42 AM EDT

The Dip-Buyers Inch In

  • But momentum players are still skittish.

There is decent underlying support and improving breadth underneath a mild bounce. Typically, this how recoveries have started. When the downside momentum slows, the dip-buyers start to inch in and the longer we hold up, the more money starts to flow back in. The fear of missing out starts slowly but then it builds the longer the market stays in positive territory.

There was a big reversal in the biotechnology sector intraday and solar energy is doing well. That tandem has been leading the market in both directions, so it is promising to see the action pick up there. Precious metals continue to look good and there isn't any notably weak group.

We saw similar action in March. After a nasty breakdown in the iShares Russell 2000 (IWM), a good-sized bounce lasted three days before rolling over again to a lower low. I'm not predicting that this will play out the same way, but it is interesting that it is playing out during earnings season just as it did in March and April.

The action is fine for now and that is drawing folks back in, but the momentum players are still skittish. Small-caps and momentum stocks are the key to this market and, while they are acting better, they suffered some damage and need time to heal.

July 09, 2014 | 10:39 AM EDT

Digging for Gold Miners

  • The group has caught my attention.

After two days of selling there's a weak bounce attempt and the iShares Russell 2000 (IWM) is already back in negative territory. Even worse, breadth is negative again with about 2,400 gainers to 2,700 losers. The majority of sectors are green with solar energy and precious metals leading, but biotechnology is under pressure and chips are lagging. Momentum stocks are mixed but the bounces are not very energetic so far.

The bulls are used to the market quickly shrugging off action like the last couple of days, but the recovery attempt is anemic today. Many traders are thinking back to March and April, when hesitance to be more defensive proved costly even though it was never really reflected in the indices.

If the indices challenge yesterday's lows and begin to see lower lows, the technicians will worry about this uptrend. It is still not too badly hurt, but there is pressure and it can't build too much more before real damage is done to the trend line.

I've raised cash the last couple of days and while there are a few things I want to bottom-fish, such as Tarena International (TEDU) and Tower Semiconductor (TSEM), I'm in no hurry. Gold miners are interesting and I am building a position in Direxion Daily Junior Gold Miners Bull 3X Shares (JNUG). Primero Mining (PPP), a thin gold-mining play with a cup-and-handle pattern, is also on my radar.

At the time of publication, Rev Shark was long TEDU, TSEM, JNUG and PPP, although positions may change at any time.

July 09, 2014 | 8:32 AM EDT

The Pain of Disciplined Trading

  • It may hurt, but it'll allow you to avoid far greater damage later on.

The best preparation for good work tomorrow is to do good work today. --Elbert Hubbard

Momentum names and small-cap stocks have been hit hard over the last two days, but the bulls are confident it is just another temporary blip that will be quickly forgotten. Over the last few years the pattern of the market has been to immediately recover after one of this ugly little selloffs. It has been said quite often that the market has no memory: After a selloff, the pain seems to disappear as if nothing has happened.

So is this just another case of a short-lived correction that is buying opportunity, rather than the start of a market top? The bulls aren't too worried, and most of the bears have been burned too often by reversals to try to press.

Markets at their highs don't just suddenly collapse. Even if it is a top, there will be a number of bounces and recoveries, as the bulls aren't quickly discouraged. Tops are made up of a series of failed bounces, and so far this market hasn't even had one failed bounce. The dip buyers still have little fear, and the bulls have seen these temporary dips many times before.

The dilemma of a market like this is that disciplined management of positions can be quite painful. Quite a few momentum players were forced to dump stocks such as Palo Alto Networks (PANW), GasLog (GLOG) and Tesla (TSLA) the last few days as they pulled back sharply. Most traders just can't sit and let losses of that magnitude occur. A disciplined trader has to act even though the market has had a strong tendency to bounce back from these dips.

The big danger is that the action will develop as it did back in March through May, when the momentum and small-cap names didn't bounce back quickly. Many traders were burned badly back then when they were not disciplined, and the losses continue to build when the stocks don't recover as they had done throughout the prior year.

Disciplined trading doesn't come without pain. You are bound to sell stocks at the wrong time no matter what, but this is necessary in order to avoid the far greater pain that results when a full-blown trend change takes place.

Right now the current uptrend is under pressure, but no significant damage has been done to the major indices. On the other hand, many individual stocks have suffered technical damage, so it has been necessary to act.

Many of the permabulls fail to make the distinction between the action in the indices vs. what is happening in individual stocks. You may be able to set tight with index exchange-traded funds, but it would be a mistake to take the same approach with many individual stocks that are seeing much more severe swings.

The good report from Alcoa (AA) is helping the mood a bit this morning, and the dip buyers look anxious to do their thing. We are set to bounce, but it will be interesting to see if the sellers start to look for exit points into strength. Typically that hasn't been the case, but market conditions will change one of these days.

There are good reasons to be more cautious now, but that has been the case many times in recent years, and it is the ever-optimistic bulls that have been proven correct.

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