Here’s what to look for and how to adjust your risk exposure.

PRE-OPEN MARKET COMMENTS THURSDAY – Yesterday the market gapped down and we had a bearish trend day. This is the second red key bar that we’ve had in the last week and it is a warning sign. We typically do not see heavier selling in August until the mega cap tech stocks have reported, but seasonal weakness is taking hold before Apple and Amazon report after the close today.

The downgrade of US Treasuries from Fitch sparked a wave of selling. Bonds have been declining before the news and this threw gasoline on the fire. Bonds have broken key support and they are down overnight. Was the downgrade that damaging to US credit?  The Fitch downgrade is not going to have a lasting impact on the market. If you look at the last downgrade in 2011, the backdrop was much different. We were just coming out of a financial crisis and the EU/ECB was on the ropes. We do not have a credit crisis at this time and the downgrade won’t impact earnings. Why are interest rates climbing when inflation is coming down? Interest rates are going up because bond managers got it wrong. During the last quarter I have been mentioning that there was a huge disconnect between the expectations for a rate cut in Q4 and “Fed speak”. Powell has been saying that they do NOT intend to cut rates this year, and they might even hike once more. That adjustment had to take place and it is happening now as Q4 draws closer. The breakdown in bonds is forcing those traders to take losses. Once this adjustment has run its course, bonds will stabilize.

“Pete you’ve been telling us to have some bullish swing trades on. Mine are taking heat, what should I do?” In the context of swing trading, you have a market forecast and you trade accordingly. It drives all of our trading. My forecast was that we would have another couple of weeks of decent price action and that mega cap tech stocks would keep sellers at bay. Sell some OTM bullish put spreads and distance yourself from the action. Expect that there could be a dip and try to take advantage of time decay during what is likely to be a couple of boring weeks. This is a neutral to slightly bullish strategy. As we get to the middle of the month, watch for signs of a market top. I have also been telling you NOT to buy breakouts, but to set alerts and buy dips for your swing trades. During the dip you evaluate the price action and if you are not seeing any stacked red candles and heavy volume, take the trade. Many of your alerts have not triggered yet because the stocks are still going down. This is exactly why we are using this strategy.

I did not expect a credit rating downgrade and the selling came early. In your trading careers, you can expect an occasional curveball. So now I have to manage the risk on the positions that I have on. We have been in the 12th hour of this rally so you should not have a boatload of long exposure. The market has a tendency to keep doing what it has been doing so you stay the course. You are aware of the patterns to look for. The long red engulfing candle last week off of a new 52-week high was a warning so you keep your long exposure light and you see what unfolds.

Now that we have seen heavy volume, it confirms resistance and we adjust our forecast.

“But Pete, I am going to lose money on some of my bullish swing trades.” Put on your “big boy” pants and take your medicine. Timing inflection points is very difficult and if calms you, know that opportunity is knocking on the door. Now that we can see selling pressure we will have an opportunity to make money on shorts. We did not have this information at the start of the week. For all we knew, the market would make a new 52-week high or it could have flat-lined for a few weeks.

I expect that we are going to probe for support today. The market should be able to avoid a bloodbath and back-to-back sell-offs are fairly rare especially when the trend has been strong. QCOM and AMD reactions were weak so traders are expecting that AAPL and AMZN will not move higher after the earnings releases. I believe that both stocks will post good numbers and that everyone will take a deep breath for a few days. The jobs report will be solid Friday. ISM services will be posted 30 minutes after the open and it was strong last month. This is risk management time for your long positions. We are likely to get a bounce in the next few days. I would wait until the reaction Friday morning before you take losses on your swings. If the bottom falls out Friday morning, you can hedge remaining longs by shorting /ES and by day trading stocks from the short side. Again, I am not expecting this, but I am ready to adjust and another round of heavy selling before the end of the week would be bearish.

A more likely scenario is that the market bounces for a few days. The buyers from the last 6 months are not going to throw in the towel so quickly. They will take one more shot at the high. That will be your chance to exit your bullish swing trades. Then I will be looking for signs of resistance and a lower high double top. If I see that I will know that the market is topping and that we can expect some selling pressure.

Look for an early probe for support today. Overseas markets were weak. A long bullish hammer off of the lod or a bullish engulfing candle will signal support. Until we see that, expect more selling.

Support is at SPY $445.