I’ll be buying stocks into any weakness this morning.
That probably seems strange. After all, I’ve been cautious/bearish during the run up over the past three months. Now that the market finally seems to be breaking down, and all the rest of the stock market prognosticators are coming over to my side of the boat, you’d think I’d be gloating about the potential for a collapse.
But here’s the thing…
I still think there’s a large-scale correction coming over the next few months. I expect the S&P 500 will drop 5% or more between now and the end of October. But conditions are oversold enough right now to justify a quick, short-term bounce. And I want to participate in the upside of that bounce.
In the words of the incomparable Yogi Berra, “It’s déjà vu all over again.”
Last Monday I wrote about the potential for a Volatility Index buy signal when the VIX closed back inside its Bollinger Bands. The stock market was oversold. And it was poised for an oversold bounce – if only to punish traders who dared to short stocks into oversold conditions.
Sure enough, that’s what happened. The S&P rallied all the way back up to 2375 – a level that has been a magnet for stock prices all through 2017. Short sellers got crushed. And the television talking heads went from talking bearish about the stock market to talking bullish again.
Then, on Thursday, the bears took back control. The S&P hit resistance at 2375 and tumbled lower.
By Friday, the S&P 500 closed at a lower low – which is a bearish indicator for the next several weeks. But – and this is the important thing for the start of this week – stocks are oversold enough right now that an oversold rally could start at any minute.
The VIX closed above its upper Bollinger Band on Thursday – indicating an oversold market condition.
It closed back inside its BBs on Friday. That’s a VIX buy signal for the broad stock market.
So, at the very least, traders should be looking for a “one-day wonder rally” – similar to what we saw last Monday. That’s what we’ve had each time the VIX generated a buy signal over the past year. We should see something similar this time, as well.
On Friday the S&P 500 closed below its lower Bollinger Band, and it closed almost 40 points below its 9-day exponential moving average (EMA) line.
Understand that whenever the S&P trades below its lower Bollinger Band, it almost always experiences a one- or two-day oversold bounce. And the S&P rarely trades more than 30 points below its 9-day EMA.
I have seen strongly oversold markets run as far as 60 points below the 9-day EMA. But it’s rare.
And during the “flash crash” a few years ago, the S&P 500 traded 100 points below its 9-day EMA.
For the most part, though, under normal conditions, a 30-point spread indicates an extreme condition.
Right now, with the S&P 500 trading 40 points below the 9-day EMA, and with the VIX flashing a “buy” signal, I have to be looking to buy stocks into weakness this morning.
I’m not looking for a long-term commitment. I’ll be happy to sell my positions in a week or two at a profit.
For this week… I suspect the bulls will have the momentum.
Best regards and good trading,
P.S. If you have any questions about my option-trading strategy, thoughts on the broad market, or a suggestion for the Market Minute or the Delta Report, let me know right here.