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Today’s market action is giving a lot of people the idea that what we saw last week was a perfect bull trap. Meaning that we’re about to have another whoosh down. Right now, I don’t buy that.
We are simply witnessing the return of volatility to the markets. Today the VIX and the VXO jumped by more than 30% (the VXN jumped almost 19%). This is the largest one day jump since the first day of trading after September 11, 2001. Historically, large increases in the volatility index correspond to positive returns in the S&P 500 both short term (the following day) and longer term (10 trading days).
There are some cross currents that give me pause though. For example, that this decline has transpired over only 13 trading days, that the small speculators in the index futures market have upped their bullish stance in the face of the decline and finally, that small traders are buying more calls (to open option positions) than puts.
So it is quite possible that we’ll go down to revisit the lows of last week. Or even zoom past them to flush out these pesky small speculators who are long right now. But for me, that wouldn’t negate this level being a significant market bottom. The reason I hold that view is that this backing and filling happens in almost all significant bottoms.
At inflection points, the market shakes with more vigor than a wet dog, trying to unhinge everyone’s position and forcing maximum pain to the maximum number of participants. It needs to do this because this is how it gathers fuel for the next expansionary phase:
What I’ll be watching for, as this volatility plays out, are sectors and individual stocks that will hold their own or go on to run higher. Those will be the next batch of leaders to ride as longs.
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