Sunday, August 9, 2009

Which Way Out of the Range Trading?

Jack Krupansky does a good job of explaining how the market works when it is bound in a trading range:
Sure, NASDAQ broke above the magical psychological level of 2,000 and the S&P 500 above the magical psychological level of 2,000 a few days ago, but as I noted on Monday all of that is merely psychological and not fundamental...

At some point, after a big enough point decline and enough loss of patience, the lower end of the trading range is encountered. Unless there is heavy selling volume, traders and short-term speculators will begin to reverse and start betting on the upside. Meanwhile many of those naive speculators who believed that a new down-leg was imminent get burned and a dramatic short-squeeze occurs. This accelerates a new bull up-leg towards the high end of the trading range...

News headlines can moderate or accelerate the bias of the process for the day, but the underlying process is about range trading.

Eventually, there is either enough mutual fund buying at the upper end of the range or mutual fund selling at the lower end of the range for the market to break out (up) or break (down.) But, right now, we are experiencing range trading with no clear net bias by mutual fund managers.

Given that money supply is not growing, my bet is that the break out of the trading range will be on the downside, once the current sideline money is absorbed. And, Jack, it will be the long side buyers that will look naive. The one short-term caveat is that if there is a bullish change in market psychology which would cause less of a demand for cash, which could put a further push to the upside move, However, even here, without new money printing, upside action will be limited, and exhausted in due time, and downside action will become the predominant direction for market action.

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