What Do You Want?
In watching the intraday market action today, I was struck by just how schizophrenic market participants are in this news-driven environment. Colin Powell's UN presentation seemed to be just what the bulls wanted to hear (or just what the shorts didn't want to hear) and by the end of the lunch hour, the DOW was once again testing that 8150 level. That was all she wrote though, with negative comments from other members of the UN council providing less than supportive comments and thus began the long slide to the lows of the day, which is very close to where the major indices sat as the closing bell rang. The question I would pose to the market is "What do you want?"
As soon as I posed that rhetorical question in my mind, I was reminded of the quirky sci-fi series from the mid-1990's Babylon 5, in which the bad guys "The Shadows" continually posed the question "What do you want?" in pursuit of individuals that were willing to help them further their agenda. What does this have to do with the current market? The Shadows continually worked behind the scenes and were seldom seen, much like the real drivers in this market are seldom seen. While the media attributed today's wild swings in the market to the ongoing debate over Iraq, I think it is important to note that the fundamentals and technicals continue to be the dominant force at work, with sentiment providing for the bulk of the intraday noise.
Everyone knows we're deep in the clutches of a nasty bear market, and the primary reason is fundamentals. Earnings are lousy, and with the economy on the ropes, there just don't seem to be any signs of that picture improving anytime soon. That persistent bearish picture is the dominant factor that has kept the broad market posting one lower high after another throughout the past year, as price action is continually pressured by the declining 200-dma. More and more, the daily price action is being driven by the action of the new momentum traders, the hedge funds. These hedge funds capitalize on each shift in trader sentiment caused by the latest news release, earnings report or political statement.
The dominance of these funds' activity in the markets can be seen on two fronts. First, daily volume on both the NYSE and NASDAQ continues to atrophy, allowing the same amount of hedge fund trading volume to constitute a progressively larger portion of total daily volume. The other visible result of the dominance of the hedge funds is that Buy and Sell programs seem to cover much more ground, much more quickly than in the recent past. The result is that when these funds decide to either go long or short, they have a larger impact on the movement of the market. Look at the magnitude of the movement generated today. The shorts covered as Colin Powell's speech got underway, quickly driving the DOW up to 8152. Action stalled out and then proceeded sharply lower on renewed shorting. This was all on news that really wasn't news at all. His presentation was very much in line with what was expected and the response of other members of the international community was as expected also.
In fact, 7 out of the last 8 days have seen the DOW stage a triple-digit move. But it remains pinned between 7900-8150. A tremendous amount of energy has been expended, yet we really have gone nowhere since the close of 7989 on January 27th. This back and forth action shows the indecisive nature of the market right now and clearly the market 'wants' something before moving outside this range. It is my belief that the market isn't expecting any good news to come out of Corporate America anytime soon. So that leaves the Iraq situation. That is the issue that the market 'wants' resolved and it will have a hard time moving significantly out of its current range until it has a better idea of how and when this crisis will be resolved.
Does that mean that we can't break down from here? Not by a long shot. But I think any downside action is going to be limited to roughly the 7700 level. What about an upside breakout? Less likely, in my opinion, but it could happen. That breakout won't really occur until the DOW prints 8200, and then we have heavy overhead resistance in the 8250-8300 area, the site of the recent H&S neckline break. That leaves maybe 200 points of downside potential on a breakdown and less than 100 points of upside potential on a breakout. That sure doesn't look like a winning proposition to me, especially with the current range of just over 200 points.
So what's a trader to do? My primary advice (echoing Steve Price's sentiments) is that conservative traders should not be in this market at all. Those that are comfortable with playing such a volatile market need to significantly reduce position size and play the range UNTIL it breaks. That means buying bounces from support and selling rollovers from resistance, setting stops just below support or just above resistance, respectively. What am I personally doing? Sitting on my hands. I am not an overly conservative trader, but the rapidity with which the market turns have been coming over the past week, my head has been spinning. What does this have to do with being an Options 101 column. It is my way of reminding you (and myself) that there are three valid positions: long, short and flat. Or put another way, "What do you want"? Do you want to chase every turn hoping to be on the right side of a major move? Or do you want to preserve your capital for when conditions are aligned in your favor? The current market environment, news-driven as it is, is a great time to be flat. Trending markets will return, and our primary job is to make sure our capital is safe to deploy when conditions are more favorable.
I hope this helps!