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Market Is Setting Up For A Buying Climax - Here’s Why

Posted by Pete Stolcers on January 7

Posted 9:30 AM ET – Yesterday the market rallied to new all-time highs before giving some of the gains back after the Capitol was breached. News that Democrats were likely to win both Senate seats in Georgia did not deter investors. In fact, it might have sparked buying. This is contrary to what I thought would happen and that is why I follow price, not my gut. The S&P 500 is poised to challenge the high from yesterday this morning.

Democrats have all but guaranteed a $2000 stimulus check and that $500 billion liquidity injection is carrying more weight than a possible repeal of the Trump tax cuts. On a longer-term basis, an increase in corporate taxes will reduce profits and discourage domestic investment.

The Coronavirus continues to spread and states have shut down. Most healthcare experts agree that vaccinations will not have a material impact on the spread of the Coronavirus for at least a few months. This means that Q1 will be very soft.

Yesterday ADP reported that private-sector job growth declined by 123,000 and an increase of 88,000 was expected. Initial jobless claims have been averaging 850,000 during the last month and this bodes poorly for tomorrow’s Unemployment Report. ISM services will be posted 30 minutes after the open today and it is an important number.

Stocks are trading at a P/E of 40 and valuations are extremely stretched. Option implied volatilities as measured by VXX are near historic lows and that is a sign of complacency (fear is low). Margin borrowing on a dollar basis is at record levels suggesting that investors are highly leveraged. Bullish sentiment is also extremely high and the SPY is riding the upper end of the Bollinger Band (20-day). These are all warning signs and I consider this to be a low probability swing trading environment.

Even with all of the negatives, the market continues to push higher. I believe that we could see a “blow off” rally that pushes us through the upper end of a trading channel that started in November. Those breakouts attract new speculators (FOMO) and they typically end in a dramatic fashion. The market is been in an 11-year rally and a nine-month rally. It’s foolish to pick tops so don’t get short until you have technical confirmation. A buying climax could take a few weeks to play out if it happens. I will be watching very closely and I will be prepared to buy puts on a short-term basis if I see it.

For right now, expect higher prices. Swing traders should remain largely in cash. Last night I posted a new Weekly Swing Trading Video and it highlighted 4 new bullish put spreads. I want to sparingly sell out of the money premium on strong stocks and I want to take advantage of accelerated time decay. The stocks in the video have rallied more than 75% of the time just before earnings announcements during the last three years. This is a statistical edge I can lean on and stock selection is critical given the market backdrop I’ve outlined. A year ago I highlighted similar circumstances and I took a lot of criticism. The market was making daily all-time highs and we were largely in cash. A couple of weeks later we had the largest market selloff since the Great Depression. I’m not looking for a repeat performance, but the table is set for a decent pullback.

Day traders are in a sweet spot. I plan to take advantage of market strength and I am focusing on the long side. If the stocks have particular strength during the course of the day I will take partial profits and hold some of the position overnight. On gaps higher like we have today I am quick to take profits on overnight swings. Banks, retailers, marijuana companies and clean energy stocks have been strong. Heavy Buying, Relative Strength 30 and Bull Run are my favorite Option Stalker day trading searches. I have also been using the new Heikin Ashi custom search variables to find intraday opportunities. Yesterday I missed the early rally and I did not chase. I was able to patiently wait for an opportunity later in the day and I caught some nice trades. I will not be chasing the early gap higher today either. Gaps up to a new high have often been faded and I will wait for a pause or a pullback before I buy. These market moves help me filter out the “fakes” and they help me to identify stocks with relative strength. Be patient and wait for your opportunities to set up. If we get the “blow off rally” that I think might be coming I will participate on a very short-term basis and I will be watching for that climax.

Support is at SPY $369 and resistance is at the all-time high.
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