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Look For These Early Patterns Today and Trade Accordingly

Posted by Pete Stolcers on October 19

Posted 9:30 AM ET – Earnings season will kick into high gear in the next week and traders will be focusing on guidance. Year-over-year comps will be harder to beat since we were starting to come out of the depths of Covid-19 and stock valuations have not been this high since the “tech bubble” of 2000. The enthusiasm for earnings is high and the S&P 500 did not even test the 50-day MA Monday. In fact, the gap down only lasted a bar and we were off to the races with a gap reversal. This price action was very strong and this morning we are gapping up.

The same market forces that were in play early in the week are still present.

Reasons to be bullish:

1.Interest rates are not keeping pace with inflation (negative real returns) so investors see stocks as an attractive investment alternative.
2.Corporate buy backs are steady.
3.The long term trend is up and the market formed a base at the 100-day MA.
4.We are heading into a seasonally strong period.

Reasons to be bearish:

1.Stock valuations have not been this high since the 2000 tech bubble.
2.The Fed may start tapering in November.
3.Hourly wages are rising quickly and this will bite into profit margins.
4.Raw material costs are rising quickly and that is inflationary.
5.Global economic growth is sluggish because of supply disruptions.
6.Electricity is being rationed around the globe due to energy supply issues.
7.China is seeing a rise in corporate defaults. This could spark credit concerns.
8.Analysts are downgrading earnings expectations at a fast clip.
9.This is the heaviest selling we have seen in a year.

The market is priced for perfection and as you can see from the list above, this is NOT a perfect backdrop. These are very strong opposing forces.

Swing traders can dip their toe in the water by selling put of the money bullish put spreads. This strategy will allow you to distance yourself from the action and to take advantage of time decay. Sell the spreads below technical support. If the market is able to hold the gains from yesterday for a few more days, you can add to your bullish put spread positions. I am still expecting two sided price action and I will not get more aggressive with longs until we can close above the 50-day MA for a few days.

Day traders should not chase the opening gap up. The market has run hard the last few days and I believe that the move up will be challenged this morning. I am NOT looking for a gap reversal and a bear trend day so let me make that very clear.

If we see a mix of green and red candles and a small move higher (or a series of tiny green candles) it will be a sign that there is selling pressure. Bullish speculators will rush in and they will get flushed out. That dip will provide a shorting opportunity and patient traders will eventually have a great entry point for longs.
It is also possible that we compress before moving higher. That is another good pattern because it confirms that buyers are able to hold the gains and fend off sellers. This compression will give us precious time to find stocks with relative strength.

The final pattern is a drift back into the range with mixed green and red candles. A stubborn drift lower will be a sign that buyers are still engaged and that support will form. This is the ideal set-up today because it gives us time to confirm relative strength. The “fakes” will easily give up gains while the “gems” will grind higher as the market fills in some of the gap.

I am bullish for the next week, but the way I approach my day trading will depend on the market action I see early. On a wimpy move higher on top of the gap up I will look for a shorting opportunity and I will look for bullish speculators to get flushed out. On a compression or gradual drift lower I will be flipping charts and looking for my stocks. Once the market finds support (1OP bullish cross, bullish hammer, bullish engulf…) I will buy them.

Support is at the 50-day MA. Resistance is the all-time high.
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