To began I would like to say, this rally is HATED! Both by bulls and bears. Bears because it NEVER goes down, bulls because there is no down day or consolidation/pullback. No one is winning except the guys are already in it making a killing. Ever since the “fiscal cliff” was solved we have been on a tear… but what now? Are we extended? Are we “overbought”? Are we going higher? Are we going to pullback? If I knew the answers to these right now you can be sure I would not be telling you – I would more than likely be on my way to the bank cashing in. Since I do not however know with 100% certainty what this market will do, I will share what I think the most likely scenario is and why –
Are we overbought?
To be blunt, No. I use the McClellan oscillator (t2106 for TC2000) and it clearly says no, we are not overbought at this moment. This is most likely a result of the slow grind higher we have seen (vs. a rocket ship higher).
Are we going higher?
People sometimes over complicate this. The simple answer is, yes. The trend is your friend. Picking tops is silly, and is not recommended (I speak from experience). As long as we are trending higher – why would you say we are going down? Do not over complicate things. The odds are that you will NOT buy a top in a trending higher market – especially if you are careful with where you buy.
Are we going to pullback?
Interesting question, and one I would much like the answer to. I can tell you this though, and this is what we know… The market ebbs and flows, it goes up, and and comes down – in a cycle. So, yes, we will receive a pullback (guaranteed). The question you really want to be asking is when will be the pullback. When? I have no way of knowing – but again, the trend is your friend. We may not receive a pullback like so many expect. Instead we very well could consolidate at high level and form a high and tight bull flag to launch from. I think this is a more likely scenario. I believe this because the market is extremely strong and we have seen a potent move throughout the past couple weeks. Potent moves usually reveal what the direction will be for the time being. This is one reason for “high and tight” flag. The second helps support the first. Potent moves (like this one) that are developed slowly rather than in a day or two create a lot more areas of support and keep us from becoming overbought too quickly. A lot of times these slow grinds higher do not see a massive down move to “correct” because there is nothing to correct – we have been moving slowly. The third reason is this; the $VIX is on the dead lows and getting comfortable down there. The 8 EMA has now caught up with it and we have seen it (mostly) work off it’s “extended” characteristics by this time. By doing this it has not helped the volatility enter the market again thus, we continue a slow grind higher that in a result keeps us “not overbought” longer. I view it is a circle –
$VIX low or little volatility —> Little movements in the market create less price gaps —> Less price gaps = more support and less overbought conditions —> less price gaps/holes —> $VIX low or little volatility
People will hate a rally like this for these very reasons. People will continue to try to short and pick tops in a strong market.
Here are two analogies you could use to describe what is happening right now in the market –
Think of this type of market like a tank with heavy Armour – Every day we grind higher and gain another couple of points we had a little more Armour to our “tank”. The smaller the price movements, the stronger the “Armour” this is because the smaller the price movement the more tightly compact our support zones are thus providing ourselves with strong levels of support to defend bears with.
Think of the market like you would a large project for school, work, etc. Now how would be the best way for you to about accomplishing this project you have been assigned? Well, you have two options. 1. Rush through it and get it done as quickly as possible so you can get on with the next task. OR 2. Take your time and do it one step at a time, and make sure everything is in place just the way it is supposed to. I would hope you would choose the later. By choosing the second option you will be placing your self in a situation where you are more likely to succeed, and accomplish the project in a full manner, with fewer “holes” in it compared to if you’d had chose the first option. Make sense? Well now take that same philosophy and apply it directly to the market. By having this slow grind higher we are essentially building and working on our “project” one step at a time, making sure it is done in a full manner rather than rushing through it in a day (Ex. a 5% gap up day). This is why you see something that has gone somewhere really fast (5-10% in a week) correct more of that move than you would have if the move had happened of the course of 3 weeks.
I hope this helped. I tried to relate the market (a living organism) to something we can all understand. I know parts of this post may need to be read more than once to fully comprehend – and I recommend it. This is a very intricate analogy. Let me know if you have any questions or comments (see contact page). I will be sure to get back to you as soon as I can.
Ben C Banks.