Be Careful What You Wish For
Much to everyone's surprise, the Federal Reserve cut the Fed funds rate by half a point on Tuesday, and to further stoke the "Fed to the rescue" argument, they also took down the lesser followed discount rate (the rate at which member banks borrow money from the Federal Reserve Bank) by the same amount.
To be sure, the market's reaction – the biggest one day rally since 2002 – was unexpected by many of the so-called market pundits. Most of them anticipated that a quarter point easing would not be enough to ameliorate the current crisis. Additionally, a steep reduction in the key interest rate would give off the perception that such forceful action would be symptomatic of Chairman Bernanke's panic over the current economic slowdown. Both alternatives would have no other result than to send the market lower; so was their rationale.
A look at most sentiment indicators prior to Tuesday's FOMC meeting showed this same consensus across the board. In other words, the vast majority of market participants were betting that the indices would decline in the face of an interest policy that would not satisfy anyone.
If you've been reading this newsletter for the past several months, you know that I pay close attention to what the "majority" is doing with their money. You also know that I'm a contrarian thinker, consequently, when the masses are zigging, I'm more likely to be zagging. Some will argue that at some point in a bull or bear cycle, the preponderance of the players who are trading in the direction of the dominant trend are rewarded. To some extent this is true, but what I've found is that this stage of a market move is usually short-lived and also is very close to culminating. After more than fifteen years of trading, I've learned that at sentiment extremes – it pays more often than not - to take the other side of a crowded trade.
One of the lessons that may be learned here is that of striving to be an independent thinker. Readers know that amid all the negativity from the press and others, I have been generally positive on the market. If market action is telling me it wants to go up, (which is what it's been showing lately), then you trade in that direction. I genuinely don't pay attention to others' personal views about the market, as it only serves to cloud my judgment. It's not easy shutting-out the constant barrage of opinion and commentary, and it's even harder not to be influenced by it.
The only way to hold steadfast to your own thoughts and actions in trading is by first: having confidence in your methodology. Secondly, and above all else, one must have the psychological wherewithal to execute your plan consistently.
Let's move on to our weekly view of the charts. We'll start with a look at the daily chart of the ER2 shown below. Tuesday's rally was monstrous (33 points), but in reality, all this move did was bring us right back to that big resistance area (812-813) that I've been writing about for several weeks now. The market actually did trade nominally higher on the close, but we'll have to wait until Wednesday's trading session to see if we can vault above this resistance in a convincing fashion.
Recently, I've been sharing with readers the bullish technical patterns that have been emerging since the market lows in mid-August. The most important one, thus far, has been the double bottom I pointed out in the piece, "Has the last shoe finally dropped?". The main reason I'm bringing it to your attention now, is that if the ER2 is able to break through this important level, it will have completed the aforementioned double bottom formation and would be a very bullish signal in the near-term.
On a short-term basis (see the 10 min chart below), the market is clearly over-extended. It's rare to see the ER2 spend so much time outside of the Keltner bands. One thing to remember though, the market does not necessarily need to correct to work off these periods of being stretched or overbought. It can also go sideways for some time in order to revert to the mean.
In summary: Super Tuesday sure lived up to its name. The market got what it was asking for from the Fed and responded in-kind. If you were long going into the FOMC meeting, you had a super day. However, if you were unfortunately caught short, I hope you honored your stops. So, where do we go from here? Are new all-time highs awaiting us? Alternatively, is the Fed too late in averting a recession? These questions are what makes a market and why I love trading!
So until next time, I hope everyone has a profitable week.
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the