Tuesday, March 10, 2009

Great short-covering rally for deeply oversold stock market

The massive stock market rally today was quite a relief after weeks of vicious declines, but ultimately it was merely a short-covering rally, a heavy short squeeze, for a market that was deeply oversold, so it does not tell us anything about where the market might be headed in the coming weeks and months. The key question now is followthrough and whether the market can build on today's gains or at least refrain from giving them all up and giving us yet another bear market low ("lower lows and lower highs") within the next week or two.

The term oversold means that far too many market participants have open bets (e.g., short positions) that the markets will continue to decline and we reach the point of selling exhaustion where there is simply nobody left to do any selling in the near-term. When traders sense that the market is oversold, they begin shifting their bets to the upside and that kicks off a short-covering rally. If the rally moves quick enough, the remaining shorts quickly become under great pressure to cover their short positions, known as a short squeeze.

None of this has anything to do with the fundamentals of businesses and the economy. Sure, news reports can trigger any initial wave of buying or selling, but traders and short-term speculators have their own worldview (e.g., so-called technical analysis and chart reading) that drives any large market moves.

-- Jack Krupansky

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