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The Bad Thing About Monday’s Market Reversal

I wasn't willing to stick around too long...

In the current environment, traders should treat any big moves in the stock market like their in-laws’ holiday parties.

Show up. Be courteous, grateful, and thankful for being invited. But have a good excuse for checking out early.

I was happy to buy into weakness on Monday. But, I wasn’t willing to stick around too long.

Stocks moved sharply lower on Monday. The S&P took out the October closing low of 2632. It also broke below the support of the intraday low of the correction at 2603. And the index set a new intraday low for this correction phase at 2583.

That was enough to stretch the proverbial rubber band well into “extremely oversold” territory. At 2683, the S&P 500 was trading 90 points below its 9-day exponential moving average (EMA). Longtime readers know the index rarely strays more than 30 points away from its 9-day EMA without reversing back towards the line. So, a 90-point separation is the epitome of an overstretched rubber band.

Unless we were going to crash – an unlikely event with the market still trading so close to all-time highs (and a topic we’ll address on another day) – a snap-back rally seemed inevitable.

And that’s what we got.

The S&P reversed course. It rallied. And it actually ended the day up a couple of points. Traders who bought into weakness on Monday were rewarded by the reversal. They were further rewarded by a big gap higher on Tuesday morning.

The bad thing about Monday’s reversal, though, is it happened so fast that it prevented the daily technical indicators from closing in “extremely oversold” conditions. And it prevented the setup that often leads to strong intermediate-term rallies.

The CBOE Volatility Index (VIX), for example, closed Monday just a few pennies below its upper Bollinger Band. Regular readers know that when the VIX closes above its upper Bollinger Band, it sets the stage for a broad stock market buy signal when it closes back inside the bands. The reversal on Monday prevented that from happening.

Monday’s reversal also prevented other indicators like the CBOE put/call ratio and the McClellan Oscillators from reaching oversold levels.

So, while I appreciated Monday’s move higher off of the lows – much like I appreciate my in-laws inviting me to their Christmas party – I really didn’t want to stick around too long.

And that’s the trading environment we’re faced with today.

Think about this…

The S&P 500 closed at 2632 last Friday. It closed at 2636 yesterday – virtually unchanged.

If you had the luxury of sleeping through the past two days, you wouldn’t notice much of a difference. But, if you could follow the action, then it has been one heck of a wild ride. The S&P dipped as low as 2583. It then rallied all the way back up to 2673, before dropping back down to close at 2636 yesterday.

So… really… nothing happened.

But, traders who had a plan to take advantage of the conditions could have done quite well by buying into extremely oversold conditions on Monday and then exiting the party early – before everyone else rushed for the exits.

That’s the trading setup that’s proving to be profitable right now…

Get in when the rubber band stretches to extreme levels. Get out when the rubber band snaps back. And don’t stick around too long.

I think that’s going to be the best trading strategy for the broad stock market as we head into 2019.

Best regards and good trading,

Jeff Clark

Reader Mailbag

In today’s mailbag, readers continue to discuss Jeff’s Mastermind…

Thanks so much for this program. I have followed you for some time trying to come up with the magic key to learn option trading. This course appears to be what I have been striving for and I am excited to get started.

– Don

Thank you for your time and passion. I look forward to reading your analyses every morning with great anticipation.

– Vera

I watched your Mastermind video and I want to compliment you and your moderator on how professional the presentation was. WOW! If it was still available, I would watch again…

– Farnsworth

Hi Jeff, I’m 26 years old and recently quit my job in August to go travel the world and take a break from the corporate life. For over a year now, I’ve been reading the Market Minute which opened me up to the idea of trading, versus buying and holding long-term, since most of your predictions are usually spot-on…

Anyway, I just wanted to thank you for everything you’ve done. Aside from the successful predictions, I truly value the lessons you teach along the way. Good luck with your new Mastermind class! Thanks.

– Matias