Volatility is usually followed by a departure from fundamentals and eventually technical patterns take over. This happens more and more when markets recover from sharp sell-offs. This is a phenomena which occurs counter the existing trend, meaning that if the trend is down- then the rally has technical underpinnings. We are seeing exactly this in todays action.
"Technicals matter in this market," Pimco co-CEO Mohamed El-Erian, underscoring and perhaps understating just how much statistical measures of market behavior influence trading.
In particular, analysts have been watching support tests on the Standard & Poor's 500 (INDEX: .spx) around the 1040 level and top-side resistance near 1110 as an important gage for whether the market can stay out of the recently breached correction territory and resume the aggressive bull-market run that preceded it.
"Since your valuations look good, people become more focused on technicals because now they're looking for another measure to gage their risk," says Mike O'Rourke, chief market strategist at BTIG in New York. "They already know they're getting good valuations. You're looking for secondary indicators to key decisions off."
Of course, traders and shorter-term investors have always followed metrics like the 50- and 200-day moving averages-trend lines that track the market's movement over time intervals which are used to determine where it's headed next.
A close above a moving average for several consecutive trading days indicates a breakout higher, while breaching a low often means the opposite.
Such levels certainly can be driven by news events, but often became strong psychological barriers that trigger buying and selling independent of the headlines.
O'Rourke says he is watching the CBOE Volatility Index (Market Data Express: VIX) for clues. With the VIX holding below 30, he thinks the market could have an upward bias but will need help from economic numbers.
The market has bounced off a more than 13 percent correction-level downturn, with buyers stepping in whenever the S&P gets near the 1040 which represents the 200-day moving average.
"From a macro basis, it's going to be a situation where you're stuck in this trading range, which is the technicals, unless something unforeseen happens," says Alan B. Lancz, president of Alan B. Lancz and Associates in Toledo, Ohio. "In that sense, it's going to take an awfully big piece of news to trump the technical levels right now."
In such an environment, the investment strategy is pretty straightforward, says Lancz: Sell into rallies and buy the dips until the market shows signs of a breakout.
"Get more defensive. Look at companies that haven't moved yet if you do have this trading-range type of market," he says. "You can buy more cyclical companies that have taken a beating that can offer some opportunity for a bounce-back rally."
The important observation for this rally is that it is coming in a counter cyclical nature, few have accepted that we are in a long term decline. Certainly not this writer.
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