"Human beings are pattern-seeking animals. It's part of our DNA. That's why conspiracy theories and gods are so popular: we always look for the wider, bigger explanations for things."
The key to navigating the market is to stick with themes and patterns that are working and to react quickly when they stop working.
It is extremely important to stay open-minded and not to let biases about the overall market impair your objectivity. Bears are often prone to read too much into small negatives while bulls are inclined to dismiss important shifts. Knowing when the market has undergone a change in character is not an easy task, but the price action is always the best guide.
During the past week we have seen some shifts that have not occurred in quite a while. The big change started a week ago when the Nasdaq 100 QQQ and related technology and FAANG (Facebook (FB) , Apple (AAPL) , Amazon (AMZN) , Netflix (NFLX) , and Alphabet (GOOGL) ) names sold off sharply. Rather than bounce back, that money rotated into new sectors including financials, oils, retail, transports and a few others.
That rotation continued as the QQQ refused to bounce. Finally, yesterday, a bounce developed and it was looking like some of the same "buy the dip" action that has saved the market so often for so long. However, this time the bounce faded and the QQQ closed near the lows of the day. To add insult to injury, the rotation into new sectors did not occur this time. Both the Dow Jones Industrial Average and the S&P 500 rolled over and closed negative as well.
The S&P 500 is now down three days in a row within a strong uptrend. That has been practically a guarantee of a bounce for much of the last year, but this time there are signs that the underlying support has weakened. Dip buyers no longer are champing at the bit looking for an entry point. Many bulls have been wishing for weakness in recent months so that they can buy the pullbacks, but now that the action has weakened they are feeling far less optimistic about a quick and easy bounce.
Seasonally, the first half of December has a history of weakness, but that generally sets up a strong bounce to end the year. The proverbial Santa Claus rally works better if there is some consolidation first.
There is no question that the character of the market has been shifting lately, but the question now is whether the negative aspects are going to generate some momentum. Normally this is a good setup for a bounce, but as we saw yesterday there is now a greater tendency to sell into the strength.
Downtrends are a function of failed bounces and lower lows. We haven't had that occur often enough to shift the overall market trend, but we are moving in that direction. Caution is warranted. Don't let losses get out of hand.