Boy, it's getting bearish out there, with panicky headlines just as the options market is signaling that a possible pause in the selling is materializing. In other words, the stock market may be setting up for a bounce.
Sure, it seems as if the Federal Reserve has just about killed the bull market. And nowhere is this more visible than in the market's breadth, at least until the buyers, or more likely the short sellers that covered their bearish bets aggressively, came in on 1/28/22. So, again, it's worth asking "are we in a bear market?" And the answer is that, based on the recent action in the New York Stock Exchange Advance Decline line (NYAD), maybe bear market is too strong a word, but bearish trend is a highly accurate description of the moment.
At the same time, this market is so incredibly oversold that, if Friday's bounce continues, even a short-term rally if it takes hold, will likely be with such force that it will be nothing short of spellbinding. As a result, investors should acquire a trader's mindset which adheres to the following principles:
- Don't fight the Fed.
- Don't fight the market's momentum.
- If a stock does not get stopped out, keep it until the stop gets hit.
- Look for areas of relative strength in the market as this is where the new leaders will come from.
- Consider options instead of stocks to reduce risk of loss while participating in any potential upside if the market bounces in the short term.
- Keep a short-term outlook on any new trade.
Welcome to the Edge of Chaos:
"The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder." – Complexity Labs
For more on how to develop a trading plan and how to approach this market, watch my latest appearance on StockCharts TV's Your Daily Five.
AbbVie: A Big Pharma Blue Chip Stock that Could Dazzle Post Earnings
I recently recommended an options trade based on pharmaceuticals giant AbbVie (ABBV), based on expectations that the stock could break out of its current trading range after its earnings release on 2/02/22. I honestly wrestled on whether to recommend the stock versus an option because the price chart is so interesting. But, at the end of the day, the risk manager part of my brain got the final vote, so I went for the option. Here's why:
It's pretty simple actually. the market is still very dicey, which means that, if the entire market rolls over, the risk of loss is higher, regardless of how good a company is. A call option, on the other hand, offers a great way to participate in the upside potential for the stock while limiting the loss to the purchase price of the contract.
Now, why do I like ABBV so much? Firstly, the company has been firing on all cylinders, having beaten expectations handily in Q3 while raising its full year's guidance. Secondly, while the market has cratered of late, the stock has held up quite well.
Of course, there are no guarantees that ABBV will beat its earnings. And no one knows what the market will do even if it delivers a sterling earnings report and offers more upbeat guidance. But, as far as we can tell, the stock is currently in strong hands, which is very encouraging.
Digging deeper into the price chart, we can see encouraging indicators as well. Specifically, Accumulation Distribution (ADI) has been moving higher of late and has not broken down in a tough market. On Balance Volume (OBV) is very strong, which means that expectations are high for a big post-earnings move. And Volume by Price (VBP) suggests that, if the stock can move above $140 decisively, it could its run for a while.
The bottom line is that, in this market, there are still stocks worth considering on the long side while, at the same time, options can offer more risk-averse ways to participate.
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Market Breadth is Bruised but May Recover in the Short-Term
Another week gone by, and we saw yet another new low in the New York Stock Exchange Advance Decline line (NYAD). Yet, as we saw with Friday's late day rally, it is possible that the sellers are nearly exhausted. This was suggested by the decrease in the CBOE Volatility Index (VIX) on Friday, which coincided with a rebound in NYAD and the major indexes.
Certainly, NYAD is now well into bear market territory, having broken decisively below its 200-day moving average. And since it is well oversold, as illustrated by the RSI residing well below 30, the odds for a bounce are fairly good. Of course, the key is twofold: how good a bounce we get and how long it lasts. Remember that a rise in VIX signals that put option volume (bets that the market is going to fall) are on the rise. What follows when that happens is that these rising put volumes cause market makers to sell puts, simultaneously hedging their bets by selling stocks and stock index futures.
Of course, the reverse is true, which is what we saw Friday afternoon. Now, if the current trend continues, we may be out of the woods for a bit. But I'm not getting my hopes up too much on this.
So, what would make this trend reversal last? One thing would be that put volume continues to decrease so that the market makers can ease up on their selling. The other, and this would be even better, would be that actual call buyers return to the market so that the process can be reversed.
Meanwhile, the S&P 500 (SPX) turned up and closed just below its 200-day moving average, with both Accumulation Distribution (ADI) suggesting that the short sellers are giving up for now and On Balance Volume (OBV) suggesting that a smattering of real buying came in. A further improvement in these indicators with a decisive move above the 200-day moving average would be a bullish short-term development.
The S&P Small Cap 600 index (SML) also remained well below its 200-day moving average.
The S&P Small Cap 600 index (SML) also broke well below its 200-day moving average. And, although it's clearly oversold, it could move decidedly lower.
To get the latest up-to-date information on options trading, check out Options Trading for Dummies, now in its 4th Edition – Get Your Copy Now!
#1 New Release on Options Trading
Good news! I've made my NYAD-Complexity - Chaos chart (featured on my YD5 videos) and a few other favorites public. You can find them here.
Joe Duarte
In The Money Options
Joe Duarte is a former money manager, an active trader and a widely recognized independent stock market analyst since 1987. He is author of eight investment books, including the best selling Trading Options for Dummies, rated a TOP Options Book for 2018 by Benzinga.com and now in its third edition, plus The Everything Investing in Your 20s and 30s Book and six other trading books.
The Everything Investing in Your 20s and 30s Book is available at Amazon and Barnes and Noble. It has also been recommended as a Washington Post Color of Money Book of the Month.
To receive Joe's exclusive stock, option and ETF recommendations, in your mailbox every week visit https://joeduarteinthemoneyoptions.com/secure/order_email.asp.
