Morning Market Thoughts

by DAN Good morning. The market continues to trade in its tight range. The longer this range persists, the healthier the market becomes. Sounds a bit contradictory, but it’s not. If a chart shows a stock/index up at a prior high a couple of months of rest (as we see in the S&P in early March, and now again last week), it can be indicative of a double top. Prices rose to an all time high, pulled back, retested that all-time high…and were unable to get above that level. Supply just overwhelmed demand and the stock reversed course.

But if the price moves back up to the prior high and just hovers there, it’s indicative of persisting demand at high levels. And that persistent demand is being met by enough supply to keep the stock/index from moving higher, but not so much supply that the demand is overwhelmed. In this latter case, the AVERAGE cost basis of all recent buyers is within a pretty tight range. Nobody is complacent because they are doing so well, and nobody is fearful because they’re losing money. Rather, everyone is simply waiting for their risk to pay off. And the longer those levels persist, the bigger that crowd gets. Nobody selling. Nobody buying aggressively. And traders who were waiting for more of a pullback start to become a bit nervous that the market is going to take off without them. So they start buying a little stock too.

Can you envision this? A gradual influx of people into a tight space. At some point, the crowd is going to get so big that the tight space expands and finally pops. Boom! We have another move higher and the uptrend continues.

But if there is no crowd buildup, this dynamic never develops. Rather, some buying pressure takes the stock/index up to its prior high and meets sufficient supply to get the stock that the bulls want. But there is not enough of them to keep buying. Very quickly, traders who own stock see this test of the prior high as an opportunity to take profits. They start doing that, and boom! The stock/index falls, and we have formed a double top.

So the longer the S&P trades within this tight range, the stronger the range becomes. And the more likely it is that the trading range is becoming a base from which stocks spring higher rather than a ceiling that will put a cap on any rally.

We’re not there yet. The current tight range is just 7 days old. And the longer congestion in the S&P (between 2,350 and 2,400) is just now at a point where the 50-day moving average has caught up to it.

So my suggestion is to simply watch the action play out. There are plenty of stocks which are giving us nice gains, but most are just marking time. Wait for evidence that the current trading range is truly a base rather than a top. Trust me. If this range leads to an upside breakout, you’ll have plenty of time to get in. And if it instead turns out to be a top (remember…we are entering the slow season where SPF is more important than SPX), then you’ll be glad that you weren’t complacent.

See you in the forum! We’ll be looking at Tesla (TSLA) and Facebook (FB). Both are down pre-market…though I suspect they’ll just be met by sufficient demand to keep their decline shallow and brief. (Think “AAPL”).

–Dan

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