The S&P 500 is down more than 50 points overnight. Here’s why.

PRE-OPEN MARKET COMMENTS WEDNESDAY – Yesterday the S&P 500 closed at an all-time high and everything looked great. There were not any major economic releases or statements from the Fed. Overseas markets were down marginally. What gives?

I’ve been warning you for the last few weeks that this rally is due for a pullback. That doesn’t mean we start buying puts. It means that we go to cash and we stick to day trading. The risk of an overnight drop is elevated so we reduce our swing trading risk. The market rally is over-extended.

There is an ascending wedge formation, the volume during the last leg of the rally has been light (low conviction), the candle bodies are tiny and the “dogs” are bouncing. I’ve referenced all of these warning signs.

Chip maker ASML reported earnings overnight and the guidance was weak. Semiconductor stocks have been leading the rally on optimism that AI will be the “next big thing”. Valuations are stretched and all it took was one “miss” to tank the market. ASML will take the blame, but the sell off could have been sparked by any news at this price level. Bullish speculation is high and long-term buyers have not been interested at these levels. That’s why the volume has been light.

This has been a low probability environment for swing trading and I have been urging you to reduce risk. Some of you heeded my warning and you are safely watching the storm roll in. You will objectively monitor the price action and you will make money during this move while other traders scramble to make adjustments and to mitigate losses.

When we trade, we play the odds. The probability of a 10% move higher from this level was much lower than the probability of a 10% drop. We know this from the “tells”. The market trades in cycles and I often compare trading to a NASCAR driver. We were coming up to a turn and we needed to take our foot off of the gas. We will evaluate the depth and duration of the drop and we will wait for the next straight-away.

“Pete I’m trapped. What should I do now?” You should go back and read my daily comments for the last few weeks and you should learn from your mistakes.

What is the market going to do today? Moves of this magnitude tend to “stick”. We might see an initial bounce, but that would be a gift. If it is wimpy with mixed overlapping candles, a good short will set up (20% chance). If the bounce features stacked long green candles with very little overlap, it is a sign that the bounce will be tall and that buyers are interested (10% chance). If the market stacks long red candles early we will find support after 90 minutes and compress in a range near the low of the day (30%). If the market has a wimpy decline with mixed overlapping candles we will drift lower in a choppy fashion. This is the most likely scenario today (40%). Bull markets die hard and buyers who have been waiting for a dip will nibble along the way. That will lead to the mixed candles and overlap. With this price action we are likely to see a nice bounce along the way. When that bounce stalls, you will have an opportunity to reload shorts (if you took gains) or to add to shorts (if you weathered the bounce). The decision to hold shorts after the first leg lower will depend on how weak the stock is. If it has not been able to bounce/retrace, you should try to weather the market bounce and add when it stalls if the stock remains weak. A big drop like this initially can produce big bounces. I would prefer to look for shorts early and then to take gains once support is established. A wimpy gap and go lower will provide us with a good entry for shorts off of a failed bounce.

“Pete this is a bunch of BS, you covered all of the scenarios!” That’s what you are supposed to do as a trader!! You assess the probability of each outcome and you game plan for the most likely ones. I’ve given you the price action to watch for. We don’t guess what the market is going to do, we trade what is in front of us. We are ready to pull the trigger for what ever plays out and the price action dictates how we will trade.

When would I entertain swing shorts? I would need to see a decent round of selling during the next two weeks and a bounce that makes a lower high in the next two weeks. That coincides with mega cap tech earnings and the FOMC.

Support is at SPY $555.80 and resistance is at the low from Tuesday. I will record a video that starts 30 minutes after the open and I will be looking for trades. I should have it posted to my You Tube channel a couple of hours into trading.