The Put/Call Ratio
The indexes have been stuck between a rock and a hard place, otherwise known as support and resistance. While many patterns have shifted to the downside, such as the Nasdaq (QQQ), S&P (SPY), Microsoft (MSFT), Apple (AAPL), Tesla (TSLA), and more, everyone is short. This is why traders need to be on the lookout for a quick, short-covering rally they can trade.
How do we know the stage is set? This can be seen through the put/call ratio. The put/call ratio has been hovering between 0.9-1.0 for the past several trading days, following an event in which it was elevated for over a week. At this juncture, while the chart patterns are rather bearish, it does make it hard for the market to fall apart.
Generally, the market falls apart when everyone is long…not when everyone is short.
Identifying a Potential Short-Covering Rally
So, what is a trader to do? Well, the first thing you must do is watch for overnight gaps. Typically, if the market experiences an overnight gap to the upside when the put/call is elevated, that can set off a short covering rally.
Now, the short-covering rally can be fierce, but it can also be short-lived. So, it doesn’t mean the indexes and mega-caps are saved. But, it does provide a trading opportunity. You have to be able to recognize it.
Check out the video to learn more about how I use the market internals and read the price action to determine if there is a tradeable move. Also, I’ll discuss which stocks are my favorite to jump on if this kicks off!
A short covering rally can’t trigger without a reason. Short sellers don’t just cover their short positions when the market isn’t rallying! If the market starts to roll over for any reason, market participants may get even more bearish, leading to more short exposure. This would lead to an even higher put/call ratio and an even more explosive short covering rally when it eventually occurs.
Short sellers cover their positions when they want to take profits when they are losing money or a combination of both. (i.e., they were making money and wanted to cut the trade because they were giving back profits.)
Now, I don’t see any significant market catalysts on the horizon, but generally, it is always something unexpected that will cause the best rallies.
Why is that? Well, it’s pretty simple! It’s because nobody would be short if there was an expected, market-ripping catalyst, right?!
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