Should You Buy This Latest Dip?

Posted On August 14, 2017 2:33 pm

Concerns about a crisis with North Korea cooled over the weekend and that’s all that the market needed to produce a gap-up open this morning. Several key members of the Trump administration commented there were no indications of immediate conflict, calming the market.

Solid economic news out of Japan and a jump in oil also are contributing to the bounce this morning, but, importantly, this is the pattern of action that has been in place for years now. The bears are not capable of building on downside momentum when they have the opportunity.

By most measures the major indices are in a precarious position as they dipped below the 50-day simple moving averages and suffered the worst week of action in some time.

Each time the market has sold off it has bounced back quickly. But what’s interesting to note is the frequency of declines has increased while the gains that follow have decreased. In fact this time Nasdaq 100 (QQQ) failed to make a new high after the sharp reversal on July 27, before suffering last week’s selling. This morning’s bounce only takes it right back into resistance at the $143-$144 level.

The bears have been increasingly confident the significant correction they have been anticipating for so long is finally here. There certainly has been plenty of support for their arguments. Earnings season, while good, has seen consistent negative reactions, the central banks are increasingly hawkish, valuations are quite high and there are several high-profile fund managers who are newly bearish. Throw in negative seasonality and the bearish manifesto writes itself.

However, the bears still are missing the key ingredient in the mix. The price action hasn’t fully confirmed the market has problems. The bears made progress last week and gained the advantage, but they keep failing when it comes to pressing the advantage. Downside momentum is the key to the correction and the bears just aren’t very good at it.

The question this morning is whether this bounce is going to lead to another V-shaped recovery or if this is an opportunity to reposition with a stronger bearish bias.

What has occurred most often in recent years is the underinvested bulls race to add long exposure and when the market doesn’t roll over again the bears are squeezed and that produces a V-shaped move.

In the old days before the Great Recession, V-shaped moves were the exception rather than the norm. After a breakdown like we had last week the bears would be looking to reload shorts and the bulls would be looking to sell into the strength. For a number of reasons, the market doesn’t act that way anymore. Bounces after breakdowns no longer are viewed as something that can’t be trusted. They now are seen as the start of the inevitable recovery back to recent highs.

The big risk is the North Korean drama could start up again very easily. Just one tweet from President Trump could impact the market quickly. This has been the first issue since the election that has had any real impact on the market and it hasn’t been overcome yet. The market for now is treating it as another rhetorical excess, but it certainly is not fixed at this point.

After last week’s action the likelihood is that you are postured defensively. The goal isn’t to rush back in and put cash to work but to see what situations develop. There are a few names on my radar I want to add back, but I’m not going to buy a gap-up open out of fear that I’ll miss out.

Monday morning gap-up opens after a poor week are not buys. The key is to wait at least an hour or so to see how well the strength is holding. If there is an inclination to sell into strength it should occur fairly fast. Only after emotions have cooled a bit will it be time to consider some fresh buys.

The bears are going to grow louder this morning and tell us why this bounce can’t be trusted, but look to the price action rather than the arguments if you want proper guidance

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.