Everyday we look for clues that might tell us where the market is headed. Yesterday we got one.

PRE-OPEN MARKET COMMENTS THURSDAY – The market has been compressing in a horizontal range for a month. The upward momentum has been waning and I thought the chances for an upside breakout were greater than the chances for a drop. Buyers have been supporting this move higher and that is why we have not seen any dips. The jobs report had the potential to be a catalyst and we have been selling out of the money bullish put spreads on strong stocks in anticipation that the market could rally after the news. The employment numbers have been good all week. This morning we learned that 303K jobs were created in March and that is better than the 200K that were projected. Hourly wages rose .3% and that was also in line. No one was worried about the jobs report. It has been exceeding expectations for over a year and it was not the cause for the decline.

Perhaps it was the war in the Middle East or in the Ukraine. No. That news has been out there and wars don’t typically have much of a market impact after the conflict starts.

Oil prices spiked and perhaps that was the reason for the market decline. No. I have seen market rallies with sky high oil prices and they are no where near those levels.

So why did the market drop so far yesterday? It’s because institutions decided to sell. The volume was very heavy and from the high to the low, the SPY moved $12.00 (20-day ATR is $4.00). This was a big move and it was a warning sign. You would NOT get a move like this if buyers were aggressive.

There wasn’t any new to justify the move, but there were some technicals in play and sentiment has been bullish. Gaps up to a new relative high often spark heavy selling. This time we did not see that move early, it took a few hours to play out. Bullish speculators liked that the market was close to breaking out to a new all-time high ahead of a big number. That made them vulnerable. When the bottom fell out, they took losses (sold longs) and they fueled the move lower. This created some of the downward momentum. In the last few months we’ve seen some red bars off of a relative high and they were quickly recaptured the next few days. During those declines, the price action on the way down was choppy with lots of mixed overlapping candles. The range was not nearly as large and that was a sign that it was just technically based selling to chase out bullish speculators. The move we got yesterday was different. These were stacked red candles and there was little to no retracement. That tells us that this is some legitimate selling pressure and that we need to respect it.

Institutions are reducing risk here. They might feel that at these levels valuations are too high and that expectations for Q1 earnings are too high. That doesn’t necessarily mean that earnings won’t be good, they view the upside potential as limited. It could be that soft economic conditions in the EU and China are going to weigh on earnings. They could feel that elevated interest rates for a prolonged period of time are going to reduce consumption. Perhaps it is all of these things. We don’t really care what has them concerned, we just care that yesterday they were aggressive sellers. That tells us that the mood is changing. 

So not what? Are we bearish? How can we go from bullish to bearish that quickly? When we are trading, we are constantly looking for “tells”. The price action the last few months has been very bullish. There have not been any dips and that is a sign that buyers are aggressive. We ride that trend until we see warnings signs. The momentum the last month has started to wane and that was a very subtle warning sign. It was certainly not bearish, but we were less bullish and we were waiting for an upside breakout. Yesterday we got a more substantial warning sign. That was a very hard smack down so we adjust our expectations. At very least, we reduce our upside expectations. We have new information in the form of price action and we are on high alert.

So, what would keep me bullish? First of all, know that bull markets die hard. If you are long (you should not have a lot on here), you will get a bounce to try to get back to the high. Earnings season is a week away and that usually keeps buyers engaged. You need to look for opportunities to reduce your long exposure. A warning has been served. We want to see the long red candle from yesterday erased in the next few days. The sooner, the more bullish. Then we want to make a new all-time high during earnings season. I would embrace that move, but NOT to the extent that I would have without that red candle. I would be more guarded/cautious and I would keep my trades shorter-term.

What would get me bearish? If the market struggles to recover the long red candle from yesterday and is we leak lower next week, that would be a sign that the selling pressure is building. During mega cap earnings if the market makes a lower high double top and if I see another long red candle off of that lower high, I will start looking for shorting opportunities.

At this stage, yesterday was a shot across the bow. It is not something that we have to react to immediately. This is when we have to be on high alert and we need to watch the price action very carefully. If we quickly erase the long red candle from yesterday, the market will get back on track, but any gains from here will be hard fought. If the market can’t recover that bar in the next few weeks, we will see some profit taking. Let’s see which scenario plays out and then let’s be ready to trade that outcome.