Wednesday, October 29, 2014

Will FED Extinguish Rally It Ignited

The market bottomed and has not looked back since October 16th, when St. Louis Fed President James Bullard, a non voting member, said the Fed should consider delaying the end of it Quantitative Easing Program. With the mid term elections so close and the economy not nearing a recession, this is wishful thinking. The Fed will end QE today as expected. The question is how will the market react over the next few days, not hours.

Price volume has been almost perfect with no distribution and several add on follow through days. Unfortunately, that is where the good news ends. 

The market has been extremely extended over the last few days, the VIX, a measure of day to day volatility, has contracted quickly, but is still making higher lows, and neither the NASDAQ or NYSE advance decline lines are nearing new highs, indicating a major contraction in the number of stocks participating in such a powerful price move by the indices, and increasing the odds of this rally being nothing more then another bull trap.

Leading growth stocks, that got out of the gate early as the market reversed two weeks ago, have behaved well and followed through in strong volume. Unfortunately, many of the breakouts are out of later stage bases and appear to be in the midst of their climax runs. Lannett (LCI), Apple (AAPL), Regeneron Pharmaceuticals (REGN), and Ilumina (ILMN), gapped out of later stage cup and handle bases, in heavy volume.

New setups are now lagging the market, as recent breakout attempts out of these new setups have been failing more often and are becoming extremely volatile, making them difficult to handle. Baidu (BIDU),  Phillips 66 Partners (PSXP), and Cousins Properties (CUZ) are setup ahead of tonight's earning's reports.

Stocks should not be consolidating while the market is charging higher in heavier volume. It is a sign of short term weakness and are prone to heavy selling during even a minor pullback. These setups must first prove they can withstand a minor market shakeout before being considered on a breakout attempt.

Short trading ideas should have been long covered. I warned traders on Tuesday, October 14th in, Now That The Correction Is In Full Swing What To Expect Next:

"With the market and most short trading ideas over extended, short traders cannot get too complacent. Traders need to start reducing recent positions that have failed to follow through and tightening stops on positions with significant profits. While it may be tempting to ride through the first market test of the fifty day moving average, it could be extremely painful, especially if the market doesn't stop and attempts to test new highs."

And tweeted the morning of October 15th: 

"Consider taking profits in short positions or at a minimum tightening stop significantly. Consider a long or two."

With so few short setups, they are probably best avoided for the next few days while the market digests recent gains. Continue to track them as most are digesting the recent selling in a very orderly fashion and could be setting up for another round of breakdowns in the next few weeks. Avon Products (AVP) and Peabody Energy (BTU) appear ready to roll over at their respective twenty day moving averages.

All signs point to the rally being another short lived rally within this latter part of the the bull market, in which a handful of leading growth stocks make progress and climax, while the rest stall and roll back over. Rewarding early longs and frustrating everyone else jumping on the bandwagon.

There is no reason to be 100% in cash. Traders should be holding a few strong long positions, and tightening stops on the rest. Only very aggressive traders should consider being heavily margined at this juncture. 
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