Last Thursday, the indices broke to the upside out of a month-long trading range. They held on to the gains on Friday and are in a good position for the start of the new week.
Despite the positive technical picture, there are good reasons for some worry. But, in the perverse way the market operates, that worry may actually be a positive rather than a negative. One of the factors that helped the indices break out last week was the high level of negativity. The bearish narrative had been gaining traction and when there as a spark of positive news about China trade it caught many market players leaning the wrong way and helped to produce the technical breakout.
While the overall technical picture is good, there are some problems. The first is that the level of momentum is still quite sedate. In the past, one of the major driving forces in an uptrend has been Fear of Missing Out (FOMO). FOMO tends to overcome all the logical and compelling bearish arguments and causes short squeezes and chasing.
In addition to sedate momentum, the other major obstacle right now is headline risk. There is potential for a setback in China trade, there is the risk of more negative economic news after the weak employment report on Friday and, most importantly, the market may still be worried about the Fed's dovishness and how effective it might be.
On Friday, Fed Chair Jerome Powell spoke in Switzerland and reiterated his stance that the Fed was prepared to do what is necessary to keep the economic expansion going. A quarter-point cut is almost a certainty at the meeting on September 18, but the market will be intently focused on the number of rate cuts that may follow.
In addition to the headline risk from China, the economy and the Fed, the indices still must deal with the negative seasonality of September. There is still a month before third-quarter earnings season starts and there are not many positive catalysts apparent right now.
Overall, it is a mixed bag, with positive technical setups but limited momentum and the potential for negative headlines. In this sort of environment, it is important to manage positions carefully and to be very disciplined with stops and entry points. There is limited opportunity in chasing strength but there is substantial risk in trying to press short positions.
The best approach right now is to focus on being reactive rather than anticipatory. This market could easily go in either direction, so focus on clues as to how the price action is developing. It is easy to formulate big picture arguments but the price action is going to determine your success.
My game plan is to keep looking for some positive setups to buy, but to make sure I keep a tight leash on my positions. I don't see any edge in index trades right now, but will be watching for an opportunity to develop for a quick downside trade.
Stay flexible and reactive. It is a positive market but there is plenty of risk.