With the NASDAQ posting its best one day performance of 2012 yesterday many are wondering if the market pullback that began in April has run its course? We’re of the belief that there is still work to be done in order for the markets to have confirmed a bottom but there are some positive signs. The S&P500 bouncing out of the 1,290-1,295 was a good sign for the bulls, and it gives people who aren’t in a clear level to trade against from the long side, and bears a level to lean into on the short side if it breaks.
One of the arguments against the bounce on Monday is that it came on much lower volume than the prior down days occurred on. The argument is that this bounce wasn’t actually a demand driven bounce, but rather a lack of supply at current levels. We agree, but we also ask what’s so bad about that? The market has shown throughout the early part of 2012 that it can rally in a market environment where there is low demand but even lower supply, and that’s what Monday was about.
The analysis in terms of volume can be a double edged sword, both for bears and bulls:
1.) Low demand and lower supply rally’s are good for oversold bounces, but they are unsustainable when in downtrends. Why? Because you better believe higher supply exists at higher levels (say 1,330-1,340 on SPX) and in order to break above those levels SPX will need much more demand.
2.) If demand does pick up, a good amount of supply has likely come out of the market already which means many bulls and bears alike could be caught completely off guard by a very strong move north… vise versa, since we know this bounce was about low demand and even in lower supply, what if the supply picks up ever so slightly? Much, if not all and then some, of the gains from Monday will be wiped out.
What makes trading such a complicated exercise is there is absolutely no way of 100% knowing what will happen first, will demand or supply be the one to increase? However, there are many indicators we can follow that will offer clues as the probability of each. Here is what we’re watching:
1.) Can the Dow Jones Transportation Index rally back above the 5,050-5,100 range or hold 4,950 on any dips? The former would favor the demand side, a failure of the ladder would favor the supply side.
2.) Can the U.S. dollar find support in the $80-$80.75 range or break resistance at $81.75? Both of these would favor supply side, a breakdown below $80 would favor demand.
3.) Will oil break back below $92 and retest its low from last week around $91 (favorable of supply side) or is it able to rally and break back above the $94-$96 range (favorable of demand side)?
4.) Will copper break back below $3.50 and retest its low from last week at $3.43 (favorable of supply side) or is it able to rally and break back above the $3.60-$3.65 range (favorable of demand side)?
5.) Will the VIX stay above the psychologically important 20 level (favorable of supply side)?
The yes’s and no’s to these questions will come in time, anything that comes in between will likely coincide with consolidation for the markets. As usual, we don’t recommend getting out in front of the market on either side and trying to guess what is coming next. Don’t think that if oil is getting close to breaking back below $92 it is automatically going to, wait for the technical events we need to see to actually happen. While you may miss out on a few % gains on the profit side, you’ll also miss out on an even bigger % loss if you get guessing and are wrong.
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