The Power of Home-Field Advantage

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MARKET WRAP UP 01/05/11

After another morning move lower, the bulls pulled off an impressive comeback to close the S&P 500 at multi-year highs, up 0.50% to 1276. In keeping with the rotation theme that I discussed yesterday, we saw the commodity sector lag, while financials and large cap leaders in the technology-dominated Nasdaq thrived. Moreover, the underlying action in terms of individual breakouts holding was more impressive than what we had seen earlier this week.

With the National Football League playoffs kicking off this weekend, now would be a good time to discuss the power of home-field advantage. In football, playing a big game on your home field can have a material effect on the outcome of the game. As an example, you have your own fans vastly in the majority in the stands, screaming their heads off in your favor. The fans are the proverbial “mob,” displaying everything you would expect to see with mass psychology at work. When they scream loudly to try to disrupt the opposing team when they have the football and are on offense, the roar of the crowd will only grow louder each time the opposing team fouls up. The fans’ success reinforces itself. It is only when the opposing team scores several touchdowns to put the game out of reach does the crowd truly quiet down, as making noise no longer has the effect it once had.

Applied to the stock market, the bulls undoubtedly have had the home-field advantage since last September. In order for the bears to quiet the bulls, they will need to disrupt the “buy on every dip” mentality. Thus, topping is often referred to as being a process. Since we know that buying the dip has been a strategy that the market has handsomely rewarded for over four months now, it logically follows that those who have been successful following this strategy will not give up so easily. Instead, they will need to be disappointed several times—much like the hometown fans in the football stadium–before they give up and quiet down.

Accordingly, as a rally matures, rather than immediately leave equities we see capital rotate from sector to sector before it eventually leaves the market for a correction. The timing of this process is extremely difficult to forecast and is, indeed, often much more damaging to a jaded veteran trader’s portfolio than picking a bottom during a downtrend. Hence, the best strategy remains one of carefully riding along the pockets of momentum that remain, closely following where the big money is flowing.

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