Withholding Judgment

 | Aug 20, 2013 | 4:25 PM EDT  | Comments
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After four days of selling, the indices managed a weak oversold bounce today. The DJIA didn't even manage to stay green, but the other indices held up despite the weak finish. Volume was light but breadth was better than 2-to-1 positive.

The conventional wisdom is that a weak oversold bounce in a market that is technically broken will fail. The theory is that trapped longs will sell into strength and bears will reload shorts. That is why technicians tend to look for retests of lows.

This market seldom follows the standard rules, though. Many traders joke that the machines don't read textbooks, but there is an element of truth to that. More often than not, the goal of programmed trading is to push market in the direction that is least expected in order to force repositioning.

We'll see how the V-shaped move attempt plays out. Every time I start to think it can't possibly happen again, it does. I'm not going to rule out that chance, but strength in interest rates and the slowness of the dog days of summer make me skeptical that the bulls can send the market straight up again.

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


Aug 20, 2013 | 2:05 PM EDT

Holding Tight

  • How the bounce plays out depends on the Fed.

The action today is exactly the setup that has led to so many V-shaped bounces in the last few years. There's a nasty technical break through key areas of resistance and conditions have become oversold.

The oversold bounce starts slowly and with a fair amount of skepticism, but then it keeps going. Eventually, the underinvested bulls grow tired of waiting for the bounce to fail and the shorts get squeezed, which helps keep upward movement going. Instead of a failed bounce, we end up climbing the wall of worry.

What determines how this bounce plays out is the Fed, which is always quick to say something dovish that would keep these moves going. This time, things are a bit different because interest rates are signaling that something has changed. The bond market is anticipating more hawkishness and becoming skeptical of the rhetoric.

Another issue that makes a V-shaped bounce more problematic is seasonality. This is a very slow time of the year with little news flow. The bears may have a greater ability to pressure the market than usual.

I continue to do very little because I'm not convinced there's enough energy to keep going in the short term. I may end up being underinvested again as the market goes straight up, but I'm not worrying.


Aug 20, 2013 | 8:54 AM EDT

Handicapping the Bounce

  • Can it turn into a V-shaped recovery?

The bulls are working hard on a highly anticipated oversold bounce. There seems to be nearly universal agreement that we are down hard enough to have a decent bounce, but there is much more skepticism that it will turn into a V-shaped recovery this time.

The pattern the last couple of years is that once an oversold bounce starts, it slowly gains momentum when the bounce holds. Usually there is low volume and it doesn't look like anything very impressive, but eventually it morphs into a straight-up move that squeezes bears and causes the underinvested bulls to chase when stocks don't roll back over.

After the breakdown we have suffered, the odds are an oversold bounce will fail as trapped bulls exit and shorts reload. But in this market, failed bounces have been very rare and those who have bet on them have been punished.

Will we see more typical technical action because the Fed is less supportive? That is the thesis in the back of my mind, but I'll let the price action be the guide, as always.

I added a little Facebook (FB) on a $50 target from an analyst, but I have left plenty of room to average in further. China stocks, which were the speculative favorites recently, have turned into landmines and I'm cutting what exposure I have left. There are still plenty on my shopping list, but it is still premature to add much.


Aug 20, 2013 | 8:54 AM EDT

A Thin and Tricky Market

  • Manage positions closely and keep stops tight.

The biggest risk is not taking any risk. In a world that's changing really quickly, the only strategy that is guaranteed to fail is not taking risks. --Mark Zuckerberg

The market correction picked up momentum Monday as worries about interest rates continue to percolate. Unlike the dip in June, there has been no "happy talk" from the Fed to bring in buyers. This market has become used to Fed members talking about continued accommodation every time there is weakness, but this time there seems to be little interest in keeping a cap on interest rates and bolstering the market

Over the last few years, I've written much about the markets inclination toward V-shaped moves. This has occurred primarily because of the Fed. The natural ebb and flow of the trading action has been circumvented by the endless Fed-created liquidity. As soon as they start talking about how they will continue to keep interest rates low we go straight back up without a worry in the world.

Traders have learned that once it bounces, the market's tendency is to go straight back up as if nothing has happened. The old adage about not fighting the Fed is the all that has really mattered for the last few years.

The issue now is whether talk about tapering in the next few months and interest rates at two-year highs indicate a significant change. Right now, the market acts as if that is a likely possibility, but you can bet that the bulls are looking for another V-shaped recovery.

The dilemma of this market is that the bulls have consistently done well by not becoming overly negative when the indices crack key technical support. If you have been a buyer when Investor's Business Daily proclaims that the market is in correction, you have done well as the market has almost always reversed and gone straight back up as soon going negative.

Unfortunately, if you are a disciplined trader, you have little choice but to cut positions, raise cash and take a more defensive approach when the market is acting like it has over the past week. There is absolutely no reason to trust a bounce other than the history of V-shaped moves.

Logically, a bounce should fail at this point as trapped bulls look for escape and aggressive bears reload. Logic, though, has not been a good approach when the Fed is propping up the market. If the Fed starts jawboning about lower rates and how tapering will be delayed the buyers are going to come in fast and hard and we'll go straight back up. The big issue is that the Fed doesn't seem to be inclined to do now.

My approach here is to manage positions closely and keep stops tight. I'll look for trades in individual stocks but I'm much more likely to flip them and not build longer-term positions. I want to add to longer term favorites like Facebook (FB), but I'll average in very slowly and keep positions small until the market improves.

The good news about this market action is that it helps to create new opportunities, but you have to be highly selective and respect the downtrend. This is where active traders gain an advantage over the buy-and-hold crowd. This is where we will produce relative performance and more than make up for not fully embracing rallies.

Keep that in mind as you navigate this thin and tricky market.

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