Ride the Momentum. No News Until Thursday. Keep Your Size Small.

August 20, 2012

Last week, trading volumes fell to levels that have not been seen since 2007. The activity was comparable to Christmas. The news scene is very light and we won’t see much action until Thursday.

Flash PMIs will be released and the results should favor the upside. Dismal results are expected in Europe and if the numbers are better than feared, the market could rally. If economic conditions in China deteriorate, traders will expect action from the PBOC. Central banks are backstopping the market and I believe stocks will grind higher.

European credit concerns have also been pacified. The ECB will support short-term bond auctions if sovereigns have sufficiently trimmed fiscal spending. This is another temporary solution. In the long run nothing has changed and long-term interest rates in Italy and Spain could spike at any time.

Corporate earnings have been strong and balance sheets a rock solid. Unfortunately, profits have come through cost cutting, not top line growth. The guidance for Q3 has been cautious.

The November elections are approaching and so is the “fiscal cliff”. Political uncertainty could weigh on the market in coming months.

Stocks have been able to rally to multi-year highs. In the short term, we looked poised to break out.

In order for the market to sell off, economic conditions in the US and China need to decline for a few straight weeks. The Fed and the PBOC will be forced to take action and the market will be temporarily satisfied. When conditions continue to weaken, traders will realize that monetary easing won’t stimulate economic activity. This could take a month to play out.

I am day trading stocks that have consolidated in a tight range for a couple of months after moving higher. That rest has given them time to gather strength and the upside breakouts have resulted in sustained moves.

I know that conditions can change quickly and I am limiting my overnight exposure.

These light volumes indicate that the level of conviction is low. Traders are taking time off before the kids go back to school. In a few weeks, the action should start to pick up. Keep your size small until then and ride the momentum.
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