The S&P 500 (SPY) is currently stuck in a range between 280 and 290. The fear of missing out is above 290. A break above 290 would very likely lead to a quick rally to 295-300. The panic is under 280. If the index loses 280, we will probably see a swift selloff to 270.
Trading in a range-bound market is not easy. It often requires playing the ranges which is counter-intuitive to many trend followers. Range-bound markets often come with a lot of choppiness, which means many false breakouts and breakdowns on the higher time frames.
Last week, we saw money flowing to sectors that are immune to the U.S. – China trade war. Enterprise software, restaurants, biotech showed notable relative strength. In a real market panic, none of those sectors will save you but as of now many money managers have chosen to hide there.
P.S. Check out my last two trading books. Both are super practical, packed with actionable information that can be put to use right away:
The best risk-to-reward trading entries in a bull market occur right after a 3-5% pullback. We just had one. The problem is that some 3-5% pullbacks turn into 10-20% corrections or into choppy sideways ranges, where only the most nimble active traders make money. This is what makes trading so challenging. The best returns usually exist when there are the most uncertainty and perceived risk.
How do we separate the pullbacks that are amazing buying opportunities from the pullbacks that could be the beginning of a lot more volatility and downside momentum? It is easier said than done.
I use the price action in momentum stocks and the market reaction to earnings. The results there are currently mixed. From one side, we saw some major breakdowns in TTD and UBNT. From another, many tech momentum stocks are showing notable relative strength by going sideways or breaking out: COUP, ROKU, TWLO, TEAM, etc.
It’s impressive how dip buyers managed to keep the S&P 500, the Nasdaq 100 and Russell 2000 above their 50-day moving averages despite the U.S. raising tariffs on China imports. Not selling off on bad news is typically how corrections end.
I lean on the bullish side but I fully understand that until SPY reclaims 290, the indexes and therefore many stocks are vulnerable; therefore, trading less and with a smaller position size continues to look like the most common-sense approach.
You understand the paradox, right. If we wait until SPY goes firmly above 290, we will miss some juicy opportunities. If we don’t, we risk getting chopped. The solution is to pick our spots and not to be constantly aggressive in the market. No one can capture all moves consistently.
Buying dips in a bull market is a high reward – low-risk setup. The challenge is that it is not as easy as it seems when you look at past charts.
Here are the four typical stages of a bull market pullback (shakeout):
Stage 1: The indexes close at new all-time highs after a few up days in a row. Everyone is buying breakouts and chasing stocks. Making money seems easy. The fear of missing out defines people’s decision making.
Stage 2: Quick and unexpected pullback. Those who bought at the highs are now underwater. We are starting to see an increasing number of failed breakouts. The sentiment is sobering up but it is still mostly bullish. There are three distinct groups of active market participants here – Group A – those who are quickly taking loses; Group B – they are buying the slight dip; and Group C – those who wait for a more significant pullback to enter.
Stage 3: The dip gets deeper. The sentiment is starting to turn bearish. There is no trace of the fear of missing out. Volatility is rising. Headlines are predominantly negative.
Group A (those who quickly cut losses in Stage 2) are starting to think about shorting stocks.
Group B (those who bought the slight dip in Stage 2) are cutting losses, complaining about how choppy the market is and are going to a mostly cash position.
Group C (those who were waiting for a bigger pullback) are now scared and don’t want to buy the dip anymore.
Stage 4: Many stocks are down to levels of potential support or are starting to recover after false breakdowns.
Group A (those who started to short in stage 3) are now underwater and starting to cut losses. Overwhelmed by the recent choppiness in their account, they have lost confidence and are not thinking about buying stocks yet despite seeing some positive developments in price action.
Group B (those who went mostly in cash in stage 3) – the majority of them still don’t trust the market but some are dipping toes in the water with small positions and seeing positive results.
Group C (those who initially waiting for a bigger pullback but got scared when it came) are still suspicious of the market activity. Most don’t do anything. Some open small starter positions.
Stage 4 is typically the environment which offers the best trading opportunities from a risk-to-reward perspective. After stage 4, there’s Stage 1 again, where everyone feels that it is safe to go back in the market and making money is easy.
This four-stage cycle repeats multiple times in a general market uptrend and it is the reason why many active traders struggle in a bull market.
Sell in May and go away or stay for new all-time highs? Last week finished with fireworks and multiple breakouts. This week starts with another trade war induced decline.
No trend can last without pullbacks which often come when complacency reigns supreme and the giddiness is at all-time highs. Dip buyers have been dominating the tape for most of 2019. This probably won’t change any time soon.
In this week’s Momentum Monday we cover the price action in AMZN, AAPL, FB, and TWTR, which are outperforming in a mixed tape. We highlighted the comeback in financials and the a few setups in software, semiconductors and biotech.
Traders are still hungry of crazy IPOs. The meat-alternative producer Beyond Meat (BYND) started trading today. Its IPO was priced at $25, it opened near $45 and it finished the day at 65 after tagging 75 intraday. A small float and a good story can make wonders for nimble traders in a bull market.
On a side note, have you seen the ingredients of BYND products? Artificial coloring, tons of chemicals, in general – generic easy to copy stuff that no health-conscious person would convert to. The market can be quite irrational in a short-term perspective and BYND can easily tag $100 but over the long-term, the market is a weighing machine and BYND is one heavy vegetarian stock that is very likely to go back below its IPO placement price of $25. I have no current position in BYND.
The price action in some recent IPOs has been pretty fascinating: PINS, TW, TIGR, ZM, JMIA, etc. LYFT has been the only dud among the recent public offerings. A small float can cause a lot of troubles if the stock market enters in a pullback mode. The same IPOs that double in a week or so, can drop 50% or more just as quickly.
For those who don’t know yet, a float is the actual number of shares that is currently available for trading.
Float = Shares Outstanding – Restricted Shares.
Most insiders are restricted from selling their shares in the first six months after their company goes public. This is why many new public offerings start with a float that is a small fraction of the total outstanding shares. For example, Pinterest currently has a float of 75 million shares vs 510 million outstanding shares.