What’s Behind Door #3?

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  • on November 10th, 2011

In my opinion, the next multi-week move will be upon us not when we a) break 1270 to the upside or b) break 1220 to the downside.  No, the clues will come on the next day when the indices are flat but a batch of key stocks trade in a clear direction.

One could interpret the whacks suffered by former highfliers $NFLX and $GMCR as signs of danger, but I see them as removal of excess.  Serious investors were not behind the late stages of those rallies, and a healthy market is not led by a narrow band of stocks driven higher by short squeezes.

The problem I see with extrapolating this fledgling uptrend into a broadly bullish event is that fundamentally we lack a sector attracting gobs of capital.  The 90’s gave us tech, the rally of the 00’s gave us natural resources…what is next?  I’m afraid the best we can hope is that a style at least becomes a theme, and large cap U.S. growth is as likely as any.

Working through my scans, I find a frustrating balance between long and short candidates, giving me little insight on whether a bullish or bearish outcome of this range is likely.  That leaves the following two choices:

1) Wait on extremes, fading the fringes after every problem/”solution” from Europe

2) Pick stocks

It feels absurd to write of a potential “stock pickers market” after a day in which 499 out of 500 $SPX stocks closed lower.  But the potential exists for just this environment, with favorable seasonals and the race for fund managers to catch up.  Jared of Condor Options has highlighted his dispersion theme; here’s a list of stocks that have passed my purely price-based screens that I am stalking for setups:

For the past few months, my trades have been exclusively index trades with mixed results trying to catch the extremes.  Having changed my mind that a retest of the Spring highs could take place, I’ve been looking more deeply under the hood to find stock candidates.  While the market may not be set to jump broadly higher, I like the fact that we’ve yet to see a divergence in the number of stocks with improving structure.  The following graphic shows a market not ready to launch higher, not ready to plunge lower, but simply trying to find a more sustainable speed and trajectory:

I will get very concerned in the coming days if 1) we retake higher $SPX prices but fail to see accompanying strength in breadth, or 2) break below 60% of stocks above.  While shorter-term measures show a decent chance of dropping back under the recent lows to probe 1200, this longer-term view tells me it will simply be another lower fringe being tested.

My job as a trader is to figure out which questions are relevant, and whether they’ve been sufficiently answered.  When the answers are crystal clear, it’s too late to act; the “uncertainty” complained about by media pundits is where the meat of the move exists.  But when my questions dominate answers, as they do today, simply waiting a day to get clarity can be the best investment we can make.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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