The market averages have been in a wide range for the past 2 months. The same could be implied for many stocks for the simple reason that during periods of heightened volatility, correlations approximate +1.00.
At some point, this range will be broken decisively and left behind. We thought that this moment was last week, when $SPY made new lows for the year, but the market reversed higher and the range survived. A few days later and $SPY is approaching the upper limit of its range. Will it matter this time again?
Most market participants have been lately conditioned to expect mean reversion from extreme readings. And by conditioned, I mean rewarded. I also fell victim to mean-reversion bias today, trying to short $SPY in the afternoon only to be stopped in the last 20min stampede. I did not feel comfortable chasing stocks after several consecutive positive days. I did not feel comfortable shorting either, but did it nevertheless. I was wrong.
Everyone expect a reversal after a few strong days and this is exactly what makes the continuation of the current upward move quite possible. During market tipping points, the obvious rarely happens, the unexpected constantly occurs. Many of the weak hands capitulated during the breakdown last week. It is fair to say that the new owners of many stocks are currently acting from a position of strength and therefore are likely to defend their holdings this time.
There is a lot of cash sitting on the sidelines and waiting for the market averages to consolidate recent gains and new long setups to show up. There are not many such setups at this time, but a lot can happen in a week of sideways action.
Historically the 3rd year of the Presidential cycle has been very strong and positive in 21 of the past 22 years. I am not implying anything as 2011 has broken a ton of records so far.
The least expected scenario for Q4 is a strong market rally and this is exactly what could actually happen. My job is to remain open-minded and prepared for any scenario.
