I think I have a pretty good grasp on general human behavior having lived and traveled all over the world. I’ve seen the mundane, the daring, the silly, the fun, the dull, the exciting, the bizarre, the brilliant and a lot of the downright stupid and probably have been guilty of a combination of all of the above myself at one time or another. Yet of all these categories it is the downright stupid that eludes me the most in observing others. Unfortunately, underestimating the stupid can actually minimize your returns in the stock market as there is no limit to human stupidity and it seems to feel the most at home in the presence of crowds. But it is part of human psychology and we must know how to deal with it. Not only our own, but that of the crowd as well. I talk about this quite a bit in trading psychology.

Think Black Fridays. Every year people camp in front of stores literally for days to be first to buy cheap stuff they could either buy online or even cheaper a few weeks later. Doesn’t matter, the crowd can’t be stopped and they rush in to buy.

Yesterday was another good example. There were people who actually thought it was a good idea to buy stocks at precisely this moment:

Primary US market price discovery mechanism: SQUEEEEEEEEEZE #NQ pic.twitter.com/yxU23lNNjl

— TheNorthman (@NorthmanTrader) August 15, 2014

Not last week at the bottom, but yesterday at the top. The higher the price the more bullish people become, the lower the more bearish. Funny stuff. Coincidentally or not, it was shortly after my tweet that the market experienced a rug pull with a now seemingly weekly Ukraine/Russia story and stocks were under severe pressure for most of the day before magically recuperating (as they always do) into the close. It was OPEX after all and we must close at least respectably.

Now the OPEX close was well advertised and I’ve talked about it at length (Trading the analog), but it is worth taking another look at how the analog finally played out:

It’s nice to be in sync with the market and we had a blast trading this analog the past couple of weeks as we even caught the Tuesday dip and reloaded for renewed strength into Wednesday and Thursday. Thursday, however, we started to flip by closing remaining longs and scaling into initial short positions.

Why would we do this given the well established OPEX precedence and the working January script? I started noticing notable weakness emerging in the underlying indicators and I outlined the short trade set-up in our daily market update and trade plan for premium members. You are welcome to read it here:

Manufactured Mirage

Does this mean I’m now super bearish and we will drop to oblivion? No, not at all, but everything is a trade right now and tactical positioning is key to extract value from a market that is finally showing some signs of volatility and riding the curves with some finesse opens the door to some beautiful trades. But the market continues to be at risk here. Let’s walk through this a bit.

Firstly on the weekly chart we can observe the $SPX is still fine even though it failed to recapture its weekly 8MA so far:

But note decision time is coming up soon. This week I asked folks on twitter on their view on how this will resolve itself and while this is not a scientific poll by any means it is nevertheless a feel of the pulse. Almost 200 people voted (thank you!) and here are the results:

A mixed picture with a leaning toward new highs coming. Makes sense as the market is actually offering a very bifurcated picture at the moment.

While the $SPX continues to follow the script on the surface other key indices are performing much poorer compared to the $SPX and their bounces are but a weak shadow of what they displayed earlier in the year:

$INDU:

$IWM:

Yet the Nasdaq has been an absolute monster as the earlier chart showed. We actually recaptured all that was lost in the week before with an over 4% run in 6 days. Truly impressive. From what I saw people left feeling bullish about the strong recovery yesterday. And, on the surface, that is one heck of a strong recovery candle:

Touch of the 5EMA and lift-off! Impressive right? Well note the color. It’s as black as Black Friday. One could even argue this looks like a classic hanging man. Those are bearish signals coming on the heels of a big up move. Putting the black candle into a larger context:

Black candles are not a guarantee of downside action, but this is the 6th occasion in recent months and each resulted in some notable downside in the days following. Also note this rally is not confirmed by underlying strength. The underlying indicators show a deterioration in strength.

This can also be seen in the $SOXX as the 50MA had been an area of support but is now resistance following its heads & shoulders pattern conclusion:

Now what does this mean going forward? Next week we have a big Fed meeting and mixed seasonality, yet the $NDX near highs in year 2000 territory. The larger correction case remains plainly obvious as the entire market continues to be wildly disconnected from its monthly middle Bollinger band. Even during the post 2008 recovery it was regularly visited as it had in all of market history with regular corrections along the way. Buyers of this market here might be well advised to keep this history in mind:

It only takes one break and this visit could happen rather quickly. Now this wouldn’t constitute a bear market or crash, but would simply be a healthy correction, yet it would likely seem rather scary for spoiled market participants that are still eager to buy every dip here still.

But this remains theoretical as long as markets are still within reach of all time highs. My view of the daily $SPX chart here yields multiple scenarios for the next few days:

Firstly note the conflicting signals here: On the one hand we have a MACD cross which is positive, yet we can also see a deterioration in the internals.

I’ve drawn several trend lines that appear to have relevance. Frankly, the Friday action could be viewed as a failed break-out above the descending trend line. It’s not a complete disaster, but the 50MA didn’t really hold.  If, in combination with the $NDX black candle, weakness emerges we may actually see a fast sell-off into the lower trend line for possible new lows and for the long awaited re-connect with the 200MA (1).

A push higher across the trend line (2) may be bullish or it may not. That would squarely depend on what would happen at the rising trend line from June/July into key resistance into the 1970 $SPX area. Failure to break through there could yield a copy move of scenario 1 and aim for a test of the 200MA.

A breakthrough of course would imply a retest of previous highs or likely new highs coming.

As you can see this makes for tricky navigating in the days ahead. And note these scenarios are of course speculative as markets will do what markets will do. Much will also depend on what Janet Yellen will offer Black Friday shoppers in ways of discounts next week. As excited as buyers have been about socks buyers are also rushing even more eagerly into the bond market and the drop below 2.4% in the 10 year yield does not signal a growth oriented economy.

Either way, traders would be well served to have an open mind and a well thought out trade strategy to navigate these waters. The recent weeks have been superb for us, but we can’t rest on our laurels. One always has to wonder where the lions are.

Those interested joining us in the daily battle can do so here in premium.

Good luck trading!