Expecting a Pullback? You May Be Waiting For a While

Listening to the market chatter this morning, market participants may have come to the conclusion that the majority believes that yesterday’s rally is unsustainable. However, that may not be the case.

For the entire month of August, the market was in a consolidation period.  It was a battle between the bulls and the bears as the S&P futures traded between 1395 and 1420 for the better part of the month.

Yesterday’s Draghi spike opened the market into a critical resistance area.  This looked like a nice setup for the shorts as the market opened up at the top of its recent range.

But this market threw those shorts a curve ball.  We opened up in the 1412 area and never looked back, continuing straight up for another 18 points.  This caught three different types of market participants by surprise:

1) Fundamental traders –  that were banking that the Draghi spike would be short-lived used the opening print on Thursday to add to their short positions.  Many of these traders expected the unemployment data to be poor again (just like the previous three reports).  So they stubbornly held onto those short positions and have possibly added to them today.

2) Technical traders - that had previously played the index short from the 1414-1418 area shorted this open as well.

3) Opening traders (OPG traders), who employ a fair value type of strategy where they calculate the fair value of the individual components of the S&P based on where the S&P futures are trading.  They buy those securities that are undervalued, and sell the securities that are overvalued relative to the S&P fair value.  These traders also got caught short on the open, as many individual components opened slightly above their calculated fair value.

All of these traders were under serious heat very quickly yesterday morning as the index, and the majority of its major components, never had any type of significant pullback.

This short squeeze drove the market up to the 1430 area in the first hour of trading.  We have now had a 5-6 hour period of consolidation where it is again a battle of the bulls and the bears, but this time I believe there are significant bears that are sitting on some ugly short positions.  Many of the traders that shorted yesterday’s open are still sitting on these losing positions hoping for a pullback.  I’ve learned one thing in my 13 years of trading, when you start hoping in a trade you are usually in big trouble.  I think those traders that are still shorting this market and hoping for a pullback are going to be rudely awakened, as I think the next major market move is going to be up again.  Stay tuned to see if this market can squeeze these shorts further.