Behavioral Trading Update for Wednesday 4/22/09

Sorry for missing the entry yesterday!  If you look at the chart above, it seems more and more apparent that the market has run out of steam and that the rally is probably over for now.  On this blog, we recommended that traders take profits right before the S&P hit resistance and 875, and it appears that a lot of people did that (certainly not as a result of this blog, of course).  And now, as we've also discussed previously, it looks like we'll trade sideways for awhile.  During the rally, investors were looking to buy on dips and ride the market up.  Everybody is now locking in those profits and taking money out of the market, but they'll be much quicker to put it back in if we hear some good news than they have been over the past several months.  Let's look at the VIX:
After seeing a massive spike on Monday, the VIX has settled back down and remains below the 40 level.  Monday's spike could turn out to have been a positive move for the market, as it reminded investors not to be too complacent with their positions, which works against panic selling and major moves to the downside.  Regardless, if the market is truly trading sideways, then it is all the more important to keep an eye on the VIX to figure out how comfortable investors are feeling and try to gauge what the next move might be.

I'll continue to suggest that this is a great time to trade on fundamentals.  If we're trading sideways, then we'll tend to see larger gains in fundamentally stronger stocks and larger losses in fundamentally weaker stocks.  Buy the stories you like and short the stories you hate.

Charts courtesy of StockCharts.com

Behavioral Update for Monday 4/20/09

Today the market began the pullback that we've been anticipating in a very big way.  The S&P broke the trendline that it's been riding to take us back down to 832, a level the market hasn't seen in a week.  Assuming the pullback continues, it'll be interesting to find out the answer to the question we've been asking here at this blog: how far will we drop?  What I've mentioned as the most likely level, and still seems most likely, is just below 800 in the S&P.  On the chart, you can see the 50 day moving average right there, and if you look back a couple of weeks you'll see that this level was positively tested only a couple weeks ago.  I think it'd be reasonable to predict that we'll trade sideways from here between 800 and 875 to rest up after the rally.  Now let's look at the VIX:

This brings the previous prediction into jeopardy.  After seeing a steady decline in the VIX over the past several days, today we saw a MASSIVE 15% increase and a return to the 40 level, which previously acted as support.  What this means is that investors became less comfortable today.  Bad news coming out of the banks, specifically the stress tests, could quickly push the VIX even higher.  If that were to happen, the game would change completely and we'd be likely to see some panic selling.  Hopefully some profits were taken from any long positions at the end of last week (a lot of profits seem to be taken today, too!), but be careful with your longs here.  This is a great time to trade on a fundamental basis.  If we end up trading sideways over the next few weeks, the strong will move up and the weak will move down.  Buy the companies with good fundamentals, short the ones without, and let things shake out for now.

Behavioral Update for Friday 4/17/09

As predicted yesterday, we hit resistance today at 875!  This is where things will get interesting.  The market has been on a relentless tear over the past month, so a pullback off of this resistance is likely.  The questions is, if we see a pullback then how far down will we go?  Those who have argued that this is a bear market rally might expect us to return to the lows of early March.  However, I would suggest that investor confidence and comfort has risen dramatically since then, and at the worst we will trade sideways with 875 as the top of the channel.  Here's the reasoning:

Once again, the VIX saw a huge drop today.  Investors are increasingly less concerned about the market falling out from under them.  This means that we'll see less panic selling and more buying on dips, as we've seen throughout this rally.  Therefore, if we see a pullback off of 875, don't expect investors to sell in a panic.

In my view, the market has two options from here:

1.) The market bounces off of resistance at 875 and trades sideways to consolidate.

2.) The market blasts through 875 and this rally continues.

Between the two options, the first is much more likely.  Next week, take profits and get ready to reload off of a pullback.

Charts courtesy of StockCharts.com

Behavioral Update for Thursday 4/16/09

Just as we've predicted over the past couple of days, investors were willing to buy Tuesday's dip to make Wednesday and Thursday positive days.  On both days we've seen rallies at the close, and it wouldn't be surprising to see today's closing rally continue through tomorrow's open.  However, there are two things to look out for: 

1.) Citi's earnings report.  Citi reports before the market opens tomorrow, and who knows what they'll have to say.  Will they play around with their accounting like Goldman?  Or will they talk straight?  Also, what will their guidance be like?  This earnings report will be HUGELY significant and we'll have to see how it plays out.  Keep in mind that Google beat the street's estimates with their earnings this afternoon, so the NASDAQ may open slightly higher than the other indices if Citi doesn't beat.

2.) We're about to hit resistance!  The S&P is rallying up to resistance at 875, and if it continues to rally tomorrow then we just might see a test of that resistance.  Would strong Citi earnings push us through?  It's possible, especially given the positive news from Google's report.  Regardless, even if we pull back off of resistance, we know that investors are still willing to buy on dips because of the VIX:

The VIX continued to fall today, following its downward trendline and creating yet another multi-month low.  This is an extremely significant reading of investor confidence.  Traders are not anticipating major downturns in the market as they have been over the past several months, so they are more willing to buy on dips.  Also, they are less likely to "panic sell", which provides the market with some cushion on any pullback that we might experience.  If you missed the buying opportunity that we pointed out on Tuesday, then wait for another pullback.  We might catch another one off of resistance at 875.

Charts courtesy of StockCharts.com

Behavioral Review for Wednesday, 4/15/09

As we expected yesterday, the market caught a little bounce off of the trendline to continue the rally.  Yesterday's close and today's open offered investors a nice dip to buy in order to participate in the rally.  We rallied at the close today, so we might see that strength continue through tomorrow's open.  The next stop for the S&P seems to be 875!

The VIX saw a very significant drop today a continued the bullish move that its been making over the past several days.  As we've written about a lot recently, investors are becoming increasingly more comfortable with the market and less concerned that the market will fall out from under them.   What this means is that even if we see a pullback (maybe off of the 875 level?), we won't see the level of panic selling that we've typically seen over the past several months.  Investors are more willing to hang on to their positions and less likely to sell.

Behavioral Review for Tuesday, 4/14/09

We saw some weakness in today's market after we got some disappointing retail numbers for the month of March...  As you can see on the chart, the S&P pulled back to and closed on the trendline its been riding throughout this rally.

Even with the bad economic data and the poor performance of the market, the VIX fell marginally and remained below its previous level of support around 40.  This means that investors are still more confident that the market won't break down than they have been in the past several months.

Today's pullback in the S&P and coinciding decrease in the VIX sets up for a great buying opportunity.  If you've been following this blog, you know that the VIX is signaling that investors are likely to buy on dips right now and they are less likely to sell in a panic.  Well, the market just gave us a dip today.  We have a great entry point here around 840 and hopefully we can ride it on up to 875.  Things may change once we hit resistance, but that's for another day.

Charts courtesy of StockCharts.com

The VIX Watch

We've been tracking the VIX lately as a solid measure of the current psychology of the market.  Last week, it gapped down below its support level around 40, signaling that investors are now less concerned about the market falling out from under them and that investors are more willing to hold onto their shares instead of selling in a panic.  Our prediction is that as a result of their renewed confidence, investors will be buying on dips and holding on.

Today, the VIX remained below its previous support level, but moved back towards its moving averages.  Tomorrow's VIX reading will be key in determining where the market will be  headed over the short run.  If it continues to trend down, then we can expect the rally to continue.  If it breaks back above its previous resistance level, then things will be uncertain from there.

A Preview of This Week's Market Behavior

As you can see on the chart, we're about to test resistance in the S&P at 875.  Intuitively, this seems like a good spot for the market to stop and take a rest, and maybe give us a pullback.  A test seems imminent!

The behavioral side of things is showing some bullishness, as demonstrated by the VIX in my previous post.  Investors appear to be buying on dips and are less likely to "panic sell" than they have been over the past several months.  As a result, I can see two possibilities for the short term:

1.) The market will move through resistance on continued strong buying.  Nothing has stopped the rally so far, so it wouldn't be surprising if this level of resistance fell quickly.

2.) The market will pullback and trade sideways.  We could see it drop back to about 790, where we saw resistance earlier and where the 50-day moving average is sitting.  Investors should be confident enough not to let the S&P slip below that level.  If we do pullback to 790, we should see investors who have been dying to jump into the market finally do it.

Between these two possibilities, I would expect that the second is more likely.  This has been a huge rally and I think that a mental breather may be in store for investors.

Chart courtesy of StockCharts.com

The VIX Breaking Down

For months, the market's "fear index" has been running at historically high levels.  However, on Thursday it gapped down and broke below a support level that had held up on multiple previous tests (see the last candle on the chart).  What this means is that traders are less concerned now with the possibility of a sharp downward (or upward) move than they have been over the past 5 months.

Investors are regaining confidence that the market won't fall out from under them.  We should continue to see a lot of buying on dips and a lot of people holding their current positions as opposed to selling.

Chart courtesy of StockCharts.com

Did the Wells Fargo News Just Extend Our Rally?

Not so fast! While Wells Fargo's positive earnings projections are significant in showing that the banking sector can still make a profit, there are still strong reasons that our current rally will slow in the short term.

1. WFC's projections reflect bank profitability, not economic growth. Wells Fargo projects that they will make record profits this quarter, but it's important to keep in mind the reasons behind those profits. Obviously, their acquisition of Wachovia contributed to their "record profits". Another big contributor was their mortgage business, which benefited from a wave of refinancing and from new customers turning away from smaller competitors in favor of the seemingly safer Wells Fargo. Note that these factors are specific to banking and do not reflect positive economic performance or consumer sentiment. It's not as if consumers or businesses are borrowing significantly more money today than they were yesterday.

2. Earnings season won't be rosy for everyone. Keep in mind that we're still in the middle of earnings season and that while several companies will have positive things to say, many will show that their struggling beyond expectations. Chevron has already warned of "sharply lower" results, and while this is tied to relatively low oil and natural gas prices, surely Chevron is not alone in its poor performance in this economy. Investors are concerned about earnings, as demonstrated by the low-volume selloff that we had right before earnings season. People are nervous about earnings and when it's obvious that some companies will come in with weak numbers, investors will be unwilling to jump into the market wholeheartedly.

The news out of Wells Fargo today was great news for the banking sector, but look for the two factors above to provide the market with some resistance, and look for the market to trade sideways through earnings season.