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Blow-off Rally Likely - Quickly Go To the Sidelines If We Hit SPY $400

Posted by Pete Stolcers on January 21

Posted 9:30 AM ET – Yesterday the market made a new all-time high as President Biden was inaugurated. All three branches of government will be controlled by Democrats and this puts us one step closer to the $1.9 trillion stimulus bill. The market is addicted to easy money and it will soon get its fix. Mega cap tech earnings will be released next week and that keeps buyers engaged. I believe that the market will be able to move higher the rest of the month and we could even see a melt up to SPY $400.

The S&P 500 has been in a gradual upward sloping channel and as long as it stays in that channel it can continue for an extended period of time. However, if the market blows through the upper end of the trading channel it will signal a buying climax. The backside can be nasty. If we hit SPY $400 in the next two weeks I believe we will see at least a 10% correction

Bullish sentiment is off the charts, margin borrowing on a dollar basis is at record levels, option implied volatilities are extremely low (indicating very little fear), valuations are stretched at a P/E of 40 and the S&P 500 is riding the upper edge of the Bollinger Band on a weekly and on a daily chart. These are all warning signs.

I believe that we could see a quick market rally and a big drop. This environment is well-suited for day traders, but swing traders need to be extremely cautious. It’s fun to play with firecrackers, but you don’t want to lose your fingers. Tread cautiously.

Swing traders should start to decrease risk exposure. Some of your bullish put spreads will expire tomorrow and a week from tomorrow. Don’t initiate new trades unless they are extremely compelling. By the end of January I will only have 20% of my swing trading capital allocated and those trades will have breathing room because I’m selling out of the money bullish put spreads. If I see the blow off rally the spreads will be trading at pennies and I will buy them back. Swing traders should not try to get cute with the last leg of this rally. Once we climax the drop will happen instantly and sell programs will kick in. Bullish speculators will get flushed out and the bottom will drop out. We are in an 11-year bull market and you should not try to short the market. Our best strategy is to view the market decline as an opportunity to sell out of the money bullish put spreads once support is established. Cash is a position and the mistake most traders make is that they always have to be fully allocated. Cash equals flexibility and this is the tactic that we used in March and September last year. The snapback rallies in a bull market are violent.

Day traders are on the brink of an exceptional opportunity. Favor the long side and watch for a melt-up. SPY $400 is my target and if we hit that level we can expect a round of profit-taking at any moment. Have 1 foot on the gas and the other foot out of the door. Trade stocks with relative strength and heavy volume. Groups that are in favor (EV, solar, crypto, biotech) have gone parabolic. Those stocks have presented excellent day trading opportunities. When the market climaxes I believe that financials and cyclicals with present solid short-term shorting opportunities. Ride the wave and be nimble. As far as the open is concerned, wait for the bid to be tested and don’t chase.

Support is at $381 and $377. Resistance is at $390 and $400.
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