Monday, December 12, 2011

Maybe a correction for the market?

Futures suggest that traders and short-term speculators are trying to engineer a correction in the stock market today. Lower futures are not necessarily a bet that the market will close lower today, but merely a bet that the market will open lower. Sometimes a lower open does in fact lead to a lower close, but very commonly the selling at the open quickly runs out of steam and reaches "selling exhaustion", at which point traders and short-term speculators cover their bets and reverse their bets back to "risk on."
 
This is part of the "testing" process. The theory is that if the recent rally really is exhausted, a weak open will be enough for short-term speculators to "throw in the towel" and lead to a decline and full-blown correction, but if instead speculators and even true investors are in fact "buying on the dip", any weak open will quickly blow up in traders faces, and lead to yet another "leg up" for the rally.
 
It is also possible to have a combination of the two, so that a weak open is followed by a mini-rally that also quickly runs out of steam and hits "buying exhaustion", which is a strong signal that the recent rally really is "over" and ready for a more significant correction.
 
I'm not betting on a particular outcome, but volatile trading with a mediocre close (a little up or a little down) is roughly as likely as a moderate rally, with a moderate correction being a slightly less likely outcome. In any case, all of those outcomes are still compatible with an overall upwards trend. Corrections are an important part of any significant bull market, or even a trading range.
 
Although Europe continues to hang over the markets, holiday retail shopping enthusiasm could easily compensate for any dark clouds still looming over the horizon. The stock market has an annoying ability to rapidly bounce between worrying about the short, medium, and longer term outlooks. Traders and short-term speculators, intermediate-term speculators, and longer-term investors can rapidly swap roles as to who is leading and who is following. It is all a matter of how much money any given group is adding or removing from the market on any given day, week, month, or year, or even any hour, minute, second, or millisecond (with high frequency trading.) There can be rallies and corrections at all of these time scales, with significant volatility at time scales shorter than any particular time scale that a particular trader, speculator, or investor may be interested in. Different people (or computers or organizations) can have different tolerances for both degree of volatility and duration of volatility.

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