The rally was tested last week and it passed with flying colors. Earlier in the week, we saw multiple failed breakouts in momentum names, but dip buyers managed to prevail. SPY pulled back to proverbially important $260 level and bounced. QQQ managed to hold above 160. In other words, what was considered a major resistance became support last week. This is bullish market development.
We are entering an interesting territory, where those who did not participate in the rally might become complacent and jump back in the market. The joy of missing out might turn into a fear of missing out. Tops are not made out of euphoria. They are not made out of slowing momentum either. They are made out of accelerating selling. There is no evidence of that yet. The 40 and the 50-week moving averages are the next levels of technical resistance.
I like to research the strongest stocks when I look for swing trade ideas. I sift through the top 1 or 2% in terms of relative strength in the current market and look for two basic types of setups: breakouts, which I can buy intraday and anticipation setups, which I can buy the next trading day if they trigger.
Breakout – a 2-3% move that might be the beginning of another leg higher that could continue several days to several weeks and deliver 5% to 20% gain. There were quite a few signals on Friday. A few examples: EVBG, AMD, FIVN, EXAS, STAA, etc.
Anticipation – tight range contraction that can potentially lead to a breakout. You buy on a new 3-day high and either sell on strength or trail your profits. The nicest feature of anticipation setups is that all research can be done after the market close and the entries can be automated via conditional orders (buy or sell stop limit orders), so you don’t need to sit in front of your screen all day. Today’s anticipation setups are often tomorrow’s breakout setups. Some current examples: WWE, RARX,etc.
The most important thing is to know when to play those setups. They don’t work all the time and in every market environment. In fact, the same high relative strength stocks can offer great shorting opportunities during corrective markets when most breakouts fail and lead to a quick move lower.
In the last quarter of 2018, the market priced in a potential recession at some point in 2019. Judging by the price action and earnings results we are seeing, the market is currently re-evaluating its thesis. Scars from violent corrections don’t heal fast. This is why there has been so much scepticism of the rally in the past few weeks. Now, we are at a point where the fear of missing out is starting to kick in.
There’s always a chance that this is just a bear market rally and everyone is being sucked in before another leg lower. Changes in sentiment don’t happen overnight. Before a major reversal, we will see an increasing number of failed breakouts and momentum stocks starting to underperform. There are not enough reasons to turn bearish.
In this Momentum Monday, we cover a few potential scenarios for the major stock indexes and go over some ideas in biotech and software.