After yesterday’s selloff, we might benefit from pondering market psychology right now. Even if we get it wrong, merely knowing by how much could be of use later. My take in recent months has been that short-covering constitutes the only source of buying power — i.e., that there are no bullish buyers of stocks, only bears made nervous by whatever news could be construed as even remotely bullish. Of course, more than six years into the most powerful and relentless bull market of them all, bears who have been betting the ‘don’t pass’ line have grown understandably skittish. That’s why they chased shares higher on the unsurprising ‘news’ Wednesday that the Fed was backing off its September commitment to a rate hike. The rally didn’t last long, and when the reversal came in the early afternoon, it started an avalanche that spilled into Thursday, producing the steepest rout Wall Street has seen in 18 months.
It Feels Different
Now, the question we should be asking ourselves is whether short-covering is about to erupt just as it did each and every time stocks weakened for more than a perfunctory few days in 2015. My gut feeling is that the broad averages will need to fall significantly lower before this effect kicks in. Although yesterday’s selling was more or orderly, if nasty, there was a palpable sense toward the end of the day that fear unlike anything we’ve seen since last autumn was starting to creep into investors’ fevered minds. This selloff ‘feels’ different, and it may need a washout to produce a sharp short-covering rally. When it comes, don’t make the mistake of underestimating its strength. A short squeeze can flout logic so maddeningly that even the permabears will be convinced they had it wrong. Yes, there are now a score of compelling reasons, many of them technical, to think we’ve entered a bear market. But it is the very acceptance of this idea that will fuel the next big rally; and if the idea is shared by nearly everyone, it’s hardly inconceivable that the rally, defying all reason and logic, will achieve new record highs. That’s what memorable short-squeezes are all about, and we should not presume to know their limits. Click herefor a free two-week trial subscription to Rick’s Picks that will give you access not only to daily trading ‘touts’, bulletins, updates and impromptu trading sessions, as well as to a 24/7 chat room that draws veteran traders from around the world.
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