When the trajectory of stocks is uncertain, it�s always a relief to see the markets have a big day. That�s exactly what we thought we were getting when the U.S. markets opened Tuesday � it was rally time. But by the closing bell, the S&P 500 had posted gains just north of 1%, far off its session highs where the index was up more than 2.5%.
Tuesday offered an important lesson: before you begin celebrating, it�s important to realize when you are not yet out of the weeds. No matter how good one moment may seem, you need to be prepared for the exact opposite reaction the next day (or even the next hour). Today, I�m going to explain how taking a significant position in this market � whether long or short � could be a huge mistake.
There is a reason Tuesday�s rally failed. There�s simply too much uncertainty for stocks to post a game-changing rally or hold significant gains. Despite recent bailout news, Europe�s financial woes continue to haunt domestic markets. Volatility is squashing what little edge afforded to traders since the August correction began.
Breaking down the recent market action, you�ll find that aside from quick flips, almost any trading edge has all but evaporated. Making aggressive bets � whether bullish or bearish � on any of the market�s recent moves would have left you stopped out (or worse) 99% of the time…
Turning to the Russell 2000, you can see that the recent market action has left our small-cap index open to multiple interpretations:
On Monday, I warned readers of my premium trading service that socks could lure longs with a push back toward the bottom of the blue line, only to eventually fall to new lows. Not only did stocks break away into the previous range � they also retested the 20-day moving average before getting knocked back to reality.
Usually, this type of retest is common when a pattern is completed � so we must view any short-term rally from these levels with a skeptical eye. Also note how the top blue resistance line is beginning to point lower. It�s a muddled pattern at best � so your best bet is to assume volatile trading between the two big red lines of support and resistance. Approach any major market moves (of 2% or greater) with a skeptical eye. If you do this � and avoid trading in size � you will have a much better opportunity to come out of this period of volatile sideways action with your brokerage account virtually unscathed.
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