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Price vs. News, The Short Squeeze Bounce, and more!

Well, another 3-day weekend has come and gone, and the indexes opened up Tuesday morning with a bang.

I have to say I am a little surprised, just because historically, especially in this market environment, sentiment over long weekends has been weak which has meant for weak opens. With the bitcoin rout this weekend, and the number of margin calls that have gone out due to the bitcoin crash, I had expected a much weaker open.

Macro Sentiment vs. Price Action

But, this is why I always tell my traders that while macro analysis and sentiment readings are essential, what really matters in this kind of market is how price gaps overnight. Sentiment can be as weak as it could possibly be, and for one reason or another, the indexes will gap up, causing short sellers to scramble.

Remember, no matter what, it’s always price before news. 

As we discussed last week, the put/call ratio is the highest it’s been since March of 2020. Do you remember what happened in March of 2020? The COVID crash hit a sudden, V-shaped bottom and rallied fiercely off of the lows. That wasn’t all that long ago, and retail investors especially are continuing to buy long stocks in the market, hoping and crossing fingers for another move just like this. Now, I’m not calling a move like that, at all, since I think we have sustained, macroeconomic issues at play, but I do think we are in for a decent short squeeze off of the lows and we could at least trade it for a few days.

The Importance of Overnight Price Action

Based on the gap up Tuesday morning, the likelihood of one coming in this week is higher than it’s been. Typically, these moves begin with a big gap up. The reason for this is because it’s the gap up that causes traders who are short to cover. Think about it this way. If you’re short, and you’re making money because the market keeps gapping down, would you continue to hold your shorts, or would you cover?

Typically, traders will tend to hold short positions, and even add to them, as the market continues making new low after low. While holding your short positions as the market falls can be good, traders also have to pay attention to target zones, which typically are key psychological values (like 3600 in the S&P, or 11,000 in the Nasdaq) that coincide with new lows on the year. When the indexes that you’re trading begin to reach targets, and sentiment gets so bearish (as seen via the put/call ratio), typically it’s time to cover those shorts and get ready for a bounce higher. In my case, I did end up covering my shorts before the Fed last week, and I am excitedly looking forward to another place I can enter some more!

Here are some more details on how I identify my target zones…

The Power of Fibonacci Analysis

I also love to use Fibonacci analysis, which I use in combination with macro factors, sentiment readings, and key psych values. Fibonacci analysis is based on the idea that you can look for targets that are projections based on what past swings have done. In this case, I was looking for extensions of prior swings. The thinking here is that price action generally moves in a pattern, and moves that occur are related to what has happened in the past. Therefore, if you measure a certain swing, like, in this example, the move from the May lows to the June highs, and then project from that zone where it could fall to the downside, that is how I come up with downside targets. With Fibonacci analysis, as it relates to extension targets, there are three target zones with each swing. Those target zones are the:

  1. 127.2% extension zone – This move means you are looking for the ticker to fall the same distance it did previously, but 27.2% more than the last one. It’s always the first target (after passing resistance) that I look for, and a good spot to start taking downside profits.
  2. 161.8% extension zone – This move means you are looking for the ticker to fall the same distance it did previously, but 61.8% more than the last one. It’s the second extension target, and at this spot, I generally take most of my profits if not all.
  3. 2.618% extension zone – This move means you are looking for the ticker to fall 1.618% more than it did last time! This is a massive move, and it only occurs in very limited situations. This target is usually only met in extreme situations.

Check out the Nasdaq futures daily chart below for more details:

NQ-FibonacciExtensions

The Nasdaq fell sharply from June highs but traded perfectly into target zones at the 127.2% extension and the 161.8% extension level. This also coincided with key psychological values at 11,000 and 11,500. 

 

As you can see, after the Nasdaq hit targets, I started covering shorts, and at this point, I’m looking for new opportunities. Those opportunities will come either in the form of short-term trades to the upside and/or setting up more short trades here!

So, where do we go from here?

Well, I think it’s fine to day trade this oversold bounce from the lows. Generally, when I do that, I focus on key, market-leading stocks, like Tesla (TSLA), Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), and Advanced Micro Devices (AMD) as I mentioned on CNBC last week. 

It’s also a great time to look for places in which you can get short. Last Thursday, we discussed some of my favorite inverse ETFs, which are pulling back and setting up nicely due to the move higher in the indexes. This is the primary place I am going to focus right now in my long-term accounts.

I haven’t made any moves yet today, but you can join me as I go through live analysis each day below…

Want to learn more? Join me Monday-Thursday in our new, Free Trading Room as I kick off the market open and discuss the best opportunities that are setting up that day! With market volatility, the situation can change on a day-to-day basis, so being able to jump in and catch some live analysis and meet with other like-minded traders is a great place to be! Click here to learn more and sign up now! 

 

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