We are seeing some mild consolidation thus far today, as yesterday’s rip-roaring afternoon rally catches its breath for at least a morning. When I think back to previous times when the market made a blow-off top, such as May 2nd, 2011, I can vividly recall bullishness reaching exuberant levels, as the killing of Osama Bin Laden spurred unwarranted enthusiasm about stocks. As I wrote on that day in this post, you are better off becoming a “method trader,” just like a method actor, in terms of tempering emotions about events outside the realm of the market especially.
However, when I compare that top, and previous tops, to what we saw yesterday, I did not see many traders, if at all, actually buying into the 200+ move higher in the Dow. Market tops are usually a process, but they certainly tend to not form when plenty of traders are hedged or outright short. They do not come when traders are quick to sell longs into strength, either. No, they usually come when the majority of traders have thrown in the towel and are chasing stocks higher for fear of missing out on the greed. Indeed, the fear of missing out on making money when the makin’ seems easy is a very powerful emotion.
Case in point: Even after the bears latched on to hopes for a top after-hours yesterday, when several banks had failed the stress tests, or in light of this morning’s New York Times Op/Ed by a Goldman employee on his way out, the chart of the XLF (ETF for financials) below shows the type of pattern that is consistent with a healthy market. We have a five-week sideways consolidation/correction through time, followed by a high volume breakout yesterday. Today, we are seeing a smallish doji to consolidate, instead of a nasty 5% reversal on heavy selling volume.
Thus, I see no technical evidence of a top being formed yet. While it seems safe to hedge, the same could have been said when the S&P 500 was at 1200, 1250, 1300, 1350. etc. From my vantage point, the most prudent market posture is in siding with the prevailing trend until proven otherwise.
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