mixed signals

On Monday, I was discussing the state of the current markets with @jdub929 and @christianhgross, two of our resident expert traders on stockguy22.com. Specifically, we were discussing selling option premium on index futures and at which levels dip buyers would emerge and support further drops in the markets. We went a step further and created a poll asking that very question. Below are initial results as of Monday's close.

While the sample size is a little small to draw sweeping conclusions about the attitudes of the trading majority, it does match up with the anecdotal evidence offered up on a daily basis on the twitter stream. Looking at the responses to the first question, it is clear to see that the majority of polled traders still believe that buying the dip is the correct strategy to take at this time. While about half of the polled traders expect a drop to between 1200-1250 before becoming heavily involved only 10% of the traders indicated that they did not have much interest in buying the markets at this time. One third of those polled took the more aggressive stance of being willing to enter long positions if we dropped between 1250 and 1275. With Tuesday's significant gap down, these traders were tested and we found that not only were they apparently telling us the truth, but they also had plenty of company as the SPX rose steadily throughout the day and finished the day about 20 points above its lows. While the bulls were able to step in and somewhat salvage what appeared to be a disastrous day, the fact remains that they are steadily losing ground now as we probe lower and lower on heavy volume. Looking at a chart of the S&P 500, we can see that while we were able to close above the 1275 “Egypt lows”, we probed significantly lower than that before buyers stepped in.

Each of the horizontal lines on the chart correspond to one of the price levels on our poll. While the first level held today, the majority of participants actually called for lower prices before they claimed they would step in and buy support. Price action is now churning between the 50 day moving average and the 100 day moving average and is firmly underneath a 20 day moving average that is no longer rising and has in fact begun to descend. Couple this with the heavy volume we keep seeing as the markets experience more distribution and it seems that the more cautious buy the dippers will soon get a chance to prove themselves as well.

However, this leads us to the second question in our poll. The chart below shows us at what price levels participants are willing to buy momentum in the event that we can rally from here.

Two thirds of the participants were ready to buy as long as we were able to either clear the intermediate resistance we've faced at 1330 or at 1350 if we were able to forge to new highs. Contrast this with about a quarter of the participants that were not interested in buying if we were to test the recent highs. Clearly, many traders are still waiting for the recent rally to resume by next month and are ready to jump back on the pomo train as soon as it leaves the station. Keep in mind that in the last couple of months we have dealt with the beginning of a cultural revolution in the middle east, the resulting burden of $100 oil and an apocalyptic disaster in one of the largest economies in the world and yet the market remains close to where it started trading this year. The continued underlying strength and resilience of this rally, even in the face of disastrous news further supports the thesis that we are currently experiencing a bull market correction and not a reversal. One of the “tells” many traders I respect use to figure out where the market is headed is the price action in copper using Freeport Mcmoran (FCX) as a proxy.

Looking at a chart of FCX, we can see that it has been mired in a steady downtrend since mid January and has indeed hinted that the broader markets were headed for a substantial correction. However, FCX had a strong move on Tuesday on very heavy volume and looks to have found a near term bottom just above the $46 area. This doesn't necessarily mean that it is ready to begin a new uptrend as FCX still has plenty of work to do in overcoming its recent downtrend, but today's strong candle hints that perhaps it is ready to base out here as it comes to terms with a new price range.

So where do we go from here? The market has shown great resiliency in the face of horrible news, but then again, how long can it ignore it? The market is experiencing its heaviest distribution since the flash crash but buyers are willing to step in at every downturn. These and many more mixed signals continue to confound traders and are reflected in their attitudes as a substantial number of them are looking for a much larger correction over the next month while nearly just as many are waiting for us to break to new highs. This is a recipe for continued choppiness as the market sorts itself out after the epic rally it underwent over the last several months. Going back to the original point of this discussion, I expect us to trade in a broad corrective range (in which we are still defining the edges) and will begin to explore more range based trades (such as selling premium) until I see the market has either fully corrected or has indeed turned lower.


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Posted in Commentary