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Market Still Has Some Downside - Don’t Jump the Gun

Posted by Pete Stolcers on May 13

Posted 9:30 AM ET – Yesterday the market sold off as inflation fear escalated. Traders are worried that the Fed’s inflation projections are too conservative and that they will be forced to tighten much sooner than they expected. Interest rates are moving higher and that is weighing on the tech sector. The market is poised for a bounce this morning, but I don’t believe we will see follow through buying.

Stocks are priced for perfection and a spike in commodity prices has sparked profit-taking. The warning signs were present when the market got a fantastic round of news (earnings, a dovish Fed and strong economic numbers) in the last few weeks and it could not advance. Option implied volatilities were extremely low and bullish sentiment was very high. Any little speedbump was going to spark selling and bullish speculators are getting flushed out.

If this spike in raw material prices was based on strong demand, the market would tolerate inflation knowing that economic activity is expanding. Unfortunately, most of the price spikes are supply related. Yesterday’s CPI reading was much “hotter” than expected and this morning’s PPI (.6% versus .3% expected) was also “hot”. In last week’s jobs report we saw a spike in hourly wages (.7%) and that is one of the largest input costs for companies.

I don’t believe that the market will have a sustained rally until support has been confirmed. The inflation backdrop is very real. It’s going to take time to determine just how high prices go and to see if the Fed flinches. In the last six months we’ve rarely seen two consecutive days of selling. I expect to see a pause for a day or two and then a probe below the 50-day moving average on the SPY. I will be watching for a deep intraday low and a sharp reversal with consecutive long green candles closing on their high (five minute basis) on heavy volume. Until buyers see that type of low, they will remain passive.

Europe is starting to reopen and that is positive. The virus is spreading rapidly throughout the world and that is negative. The global economic recovery will take longer than expected.

Swing traders should place orders to sell out of the money bullish put spreads on cyclical stocks this morning. I am trying to enter six new trades, but I will need help from the market. These stocks will have to trade lower in order for me to get filled. I like the basic materials sector (ore, oil and agriculture). These stocks all have relative strength and they will benefit from inflation. After the initial bounce this morning I expect to see another round of selling. We could test the 50-day moving average today, but the downside should be relatively contained. Bull markets die-hard and there will still be buyers wanting to buy a dip. Next week we should see some additional selling pressure and if I don’t get filled on my orders today, I will have another chance to enter next week. The inflationary pressures are not going to be resolved anytime soon and they will keep a lid on the market this summer.

Day traders should let the early bounce run its course. There will be some opportunities on the long side, but be careful. Once the bounce stalls watch for signs of exhaustion. I believe that there will be shorting opportunities after the first hour of trading. Tech stocks are weak relative to the market and there are still plenty of opportunities in that sector. After that “bid check” I expect a trading range to be established and for the market to stay in it the rest of the day. The sector rotation has been incredible and there are intraday opportunities on both sides. Use the 1OP indicator is your guide on a five-minute basis. Heavy Buying/Selling and Red Hot/Ice Cold are my favorite Option Stalker day trading searches.

Support is at $400 and $404. Resistance is at $410.50.
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