How the Market Retests Support Is Critical – Watch For This

Posted 9:30 AM ET - The market could swing either way in my opinion and this is a low probability trading environment for swing traders. The price action during the next week is critical and it will provide clues on where we go from here. The section for day traders has new instructions, but the rest of my comments are unchanged from Monday. On the bullish side of the ledger the same theme has been playing out for years. Bond yields do not keep pace with inflation (negative real returns) so investors are piling into stocks. Corporations are facing rising raw material costs, labor shortages and supply disruptions. The best investment for many of them is share buybacks and that is also keeping a bid to the market. On the bearish side of the ledger, stock valuations have not been this high since the tech bubble of 2000. China may have credit issues with the failure of Evergrande and the world is waiting to see how China responds. Electricity is in short supply in China and they are rationing it. This will impact manufacturing. Their market is in bear territory and it is within striking distance of the 52-week low. The Fed will start tapering and the market will not like it when they take the punch bowl away. September is a seasonally weak month. From a technical standpoint we have seen the heaviest selling in a year. That tells me that we are likely to probe for support one more time. That test will result in one of two outcomes and it will determine our swing trading for the next month. The SPY could make a higher low double bottom above the 100-day MA. That would excite buyers and we would grind higher into year end. Alternatively, the market could take out the 100-day MA as recent “dip buyers” get flushed out. Buying dips has been a very successful strategy in the last year and this trade is very crowded (that means the selling pressure will be heavy when bullish speculators exit). Swing traders need to be cautious. Last week you may have dipped your toe in the water when I suggested selling a few out of the money bullish put spreads. Keep them on a tight leash and use the 50-day MA as your guide. We want to close above it. Also make sure that the stock is maintaining its relative strength to the SPY. I would not add to positions until we have confirmed support (double bottom higher low). Day traders should favor the short side today. Typically after a market dip like we saw last week the market would have more than a week of bullish price action (this year we’ve seen 2-3 weeks of bullish price action). The bounce stalled early and we were not able to hold the 50-day MA yesterday. I view this as bearish and overseas markets were soft. As I noted in my comments yesterday, I am looking for another test of support. My rationale was influenced by the steady selling we have seen the last few weeks. How we retest will determine market direction for the next month. If the market finds support above the 100-day MA we will have a higher low double bottom. Buyers will be more aggressive knowing that the bid is still strong and we are likely to see a nice grind higher that lasts at least a month and it could last the rest of the year. If the market easily falls below the 100-day MA, dip buyers will get flushed out and we will see another leg lower. Buying dips has been a very successful strategy and I suspect that trade is crowded. The best scenario for us today is a wimpy bounce that lasts 30 minutes. Watch for tiny bodied candles. That bounce will give us time to look for relative weakness. A more difficult scenario is a “gap and go” on the downside. That will make it hard to short stocks because relative strength will be harder to spot and we will have to chase. I don’t see any dire overnight news that would prompt me to aggressively short on the open (especially not when we have been in a 16 month bull market rally). If we get a bearish “gap and go” I will evaluate the price action. Consecutive long red candles stacked would be a sign that the trend is strong. On the first bounce I will be looking to short. I am more likely to short ES futures today than individual stocks. We have nice movement and the snap back rallies have been violent. When I trade futures it is much easier for me to manage the trades because I only have one order to enter as opposed to 5 or 6 stocks. If I am buying, I will favor stocks because relative strength will be easy to spot. Support is at the 100-day MA and resistance is at $440 and $443.20 . .

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