I just finished our optionsource.net BreakOut Trader Analytics session where I spent most of the hour discussing why we are at a potential turning point in the stock market cycle. I'm not suggesting that we are facing a new bear market, but we are certainly overdue for a pull back and, more importantly, now is not the time to be chasing stocks.
Back a few weeks ago I suggested that we had an opportunity to catch a swing higher and referenced several technical indicators that lent credibility to that outlook. You can review that forecast by referencing my blog post titled Where Will The Stock Market Action Take Us This Week?.
Since then, the S&P hit 2000 this week, all be it on light volume and low momentum. While I believe that there is the potential for a continuation higher over the rest of the year, it is highly probable that there will be some healthy profit taking by money managers who have enjoyed substantial gains over the first three quarters of the year. Many bull market supporters on CNBC and BNN are suggesting that we are going to see money coming off the sidelines as result of having not participated in the the present rally. This may indeed be the case, but I believe that in order for investors to feel compelled to put that cash to work, they have to feel they are getting a bargain. After all, most investors and money managers look to buy low and sell high. So the question is...is this a "buy low" opportunity here? I think not.
Below is a typical diagram of a stock market cycle. Let me preface this by saying that I am not suggesting that we are in the final stages of an equity bubble. Rather, look at the below diagram as a reflection of a typical trend. Be it long term or short term, all trends have cycles.
We can take away a few things from this diagram
- Smart money and institutional investors drive the initial stages of the trend
- As the media starts cheer leading, the smart money and institutional investors will take profits as the public begins to take notice
- This profit taking offers a "buy on dip" opportunity for the late comers which facilitates a further continuation of the trend
- Once momentum begins to slow on this last leg, the participants in the early stages of the trend will sell into the strength
Even if this is not a short term top in the stock market, the current conditions suggest that early participants in this latest move higher are likely to lock in profits.
There could be a few reasons for this:
- A defensive measure to protect gains into the final quarter of the year
- A recognition of the uncertainty brought about by the current geo-political unrest
- A move to draw more buyers with a "buy on dip" mentality off the sidelines to "fund" another upswing and further enhance their profits
Regardless, what this suggests to me is that we are best to be patient, get through the long week and re-evaluate once we see how the first week of the final quarter of the year plays out.
Based on my technical observations and an understanding of market psychology I believe there is a reasonably high probability of a short term pull back. For a short term swing trader, having a few bearish trades in place to monetize this is not a bad idea. As far as taking a bullish stance, I think it prudent and responsible to protect any profits gained and evaluate the markets next week, once the long weekend is behind us and the final quarter of year is under way. That being said, in the immortal words of Benjamin Graham regarding Mr. Market " He is a patient if somewhat bipolar fellow. Subject to wild mood swings..." We need to be patient as well and let Mr. Market play his hand.
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