Bulls Gore Bears as Stocks Explode Higher

Thursday, July 08, 2010

Dow jumps 275 points as shorts are gored and bottom fishers join

Just when markets looked the worst, stocks explode to make the most people incorrect. After dropping nearly 10% in 10 days, stocks were poised for a strong short-covering rally. As always though, traders anticipate the move too early and found frustration on Tuesday as the gap up in cash markets was faded throughout the day.

Yet, it was instructive to take a look at the overnight futures as a solid gauge of why the action made some sense. Hindsight is always 20/20 and I'm not trying to provide backward-looking logic but the move in US futures on Monday night into Tuesday's open of equity markets was huge. On Monday night futures were trading at new lows for the year down 1.1% from Friday's close. The huge reversal in Tokyo from down 1.7% to up 0.8% rippled across the globe and fueled an astounding rally in Europe with all key markets up 2-3% or more. US futures followed the trend and reversed off the lows and opened Tuesday morning up 1.7%.

The fade to close the regular session opening gap throughout the day on Tuesday was only a pull-in of about half the overnight move and the backfill provided stronger support for Wednesday's move. While volume is always light in electronic markets so there wouldn't be nearly as much pent-up selling pressure, I do think the move had some logic and should not have convinced traders that the bounce had failed. After enthusiasm swept across the world it finally tempered by in the US trading session.

I was locked and loaded on Tuesday morning and bought a bunch of leaders: NASDAQ:AAPL, NASDAQ:BIDU, NYSE:VMW and NASDAQ:SNDK; as well as the market: NYSE:SPY. I held everything up for the initial opening push and then was stopped out of most of my stock around breakeven as stocks faded in.

I came in Wednesday with the same gameplan to buy strong stocks but I had less confidence even though the backfill of the previous day should have strengthened my argument, not weakened it. I ended up only in NASDAQ:AAPL and NYSE:SPY for gains and held them overnight for a larger move. I sold some this morning and will watch how the leaders hold up in the coming days but this was the first glimmer of hope for the bull case.

This recitation may or may not be helpful but I think there was a lesson to be learned by understanding overnight moves and keeping everything in context. We dropped over 900 points in 10 days on a one-way street down. A bounce was clearly going to come. The bounce didn't happen on Tuesday but the market showed no signs of failure, just a methodical gap fill. I stuck with the idea but allowed my conviction to waver and that cost me potential gains.

Disclosure: Long SPY, AAPL.
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