“The obvious rarely happens, the unexpected constantly occurs” – Irish proverb
In the foundation of price action are different cycles of confidence. The beginning of each trend is marked by disbelief. As the stock market gradually progressed in September and October, numerous market participants raced to point out the negative economic news and proclaimed the rally as unsustainable. Every minor weakness was a glimpse of hope for the bears at heart. The market kept going. What the rational minds didn’t understand was that once a new bullish cycle starts, it is likely to continue for at least 6 to 8 weeks as institutions need time to allocate capital. As for the bad headlines, they are often just a three day wonder. As Howard Lindzon insightfully shared:
The bad news will always get the headlines, but headlines don’t make you money. You get better as an investor when you listen to the tape and follow the strength. The headlines will get bullish after huge gains are made.
The market continued to climb, breakouts worked across different sectors, people made money, the confidence gradually increased and fresh capital entered. Risk appetite accelerated with every uptick. Good news was considered great news, bad news was considered good news as market participants have had the FED behind their back.
Liquidity tends to trump fundamentals and there are some solid proves about this phenomenon. On Friday, Brian Shannon from alphatrends.net highlighted an interesting observation:
This is not the time to think and worry about your usual overbought indicators and divergences wanting lower prices. The Fed wants higher prices and will succeed no matter what your oscillators will do. Just consider the impact of POMO days since September 1st compared to non-POMO days. 21 POMO days averaged a daily gain of 0.64%, 7 times the average daily return of 26 non-POMO days of 0.09%. The compounded return of all POMO days has been 14.18% vs. 2.27% for all non-POMO days!
Over the past week, the equal weighted St50 depreciated by 1.45%, but still outperformed the S & P 500 by 72 basis points and the Nasdaq Composite by 91bp. This was the first negative week on record. One thing is sure. It won’t be the last. Momentum stocks provide incredible opportunities for quick and significant profits, but if you trade them, you need an exit strategy. They are not stocks for the faint of heart. They move fast in both directions. They could provide a 30% profit in two days and then take it all back in two hours.
As various commodities were making new multiyear highs in the beginning of the week, we advised not to chase overextended names, to take partial profits and raise stops. Many of the momentum stocks are parabolic and once the enthusiasm fades, they are likely to quickly give back gains. By protecting profits, you are protecting your confidence, which is essential for consistent market success.
On the bright side, Cisco’s negative earnings release didn’t sink the tech sector. The weak open was welcomed by market participants, who fearlessly tried to “catch the knife” in their favorite names. On Thursday, we mentioned that dip buying will persist until it is rewarding. With the FED behind their back, most market participants didn’t care about any headlines about tightening monetary policy in China and renewed sovereign default risk from Europe. Strong portfolio performance often leads to complacency. When you are bullish, you tend to find a good explanation for each negative development. Needless to say, some got burned on Friday.
In the past five days, energy stocks outperformed and their number in the St50 has significantly increased. Stocks with strong earnings releases ($PCLN, $FOSL, $MSCC) didn’t care about the general state of the market as they had a catalyst, which attracted fresh institutional money.
The major market indexes continue to hold above their rising 20-day MA. Until this is the case, the path of least resistance is north.
ST50 is a powerful equity selection tool. Equity selection is a necessary, but insufficient condition for consistent market success. Disciplined risk management is needed for the latter. Patiently wait for the highest probability setups in the strongest stocks to develop before you commit any capital.
You can easily follow any or all of the stocks in the ST50 on StockTwits by clicking here
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