Market Bottoms Require Several Steps. We're Still Waiting for the First One.

Market Bottoms

The S&P 500 is looking to start in positive territory for the second day in a row, but the market's biggest problem remains the same: investors are using strength to reduce positions.

The Trump News That Moved Futures

This morning's optimism is due to a Wall Street Journal report that President Trump told aides he is willing to end the military campaign against Iran while leaving the Strait of Hormuz largely closed. Trump is concerned that trying to fully reopen the Strait would take four to six weeks, which is too long.

The amended plan is to achieve the goals of destroying Iran's navy and missile stocks, wind down current hostilities, and then pressure Tehran diplomatically to resume the free flow of trade. If that fails, Trump would press allies in Europe and the Gulf to take the lead in reopening the Strait.

This shift in posture is another TACO move and it has futures pointing higher, but like other TACO moves there are still significant problems to overcome. Crossings through the Strait have dropped by around 95%, which is now causing gasoline prices in the U.S. to move over $4 per gallon. Leaving the Strait closed while declaring victory does not solve the oil problem, and the market knows it.

Secretary of State Marco Rubio also appeared to contradict the report, saying in an interview with Al Jazeera that the Strait will be kept open "one way or another" and that war objectives could be achieved "in weeks, not months." Meanwhile, Iran's Foreign Ministry reiterated that no direct negotiations have taken place, while confirming that intermediaries had delivered a set of proposals to Tehran.

This is exactly the recent pattern where headlines give the market a boost until the next one contradicts it.

How Bottoms Actually Form

Market players are anxious to get in front of a bounce, which is why you are seeing strength at the opens. But after suffering painful losses, there is an inclination to move to the sidelines at slightly higher prices. That dynamic produces the most dangerous feature of corrections like this one: the failed bounce.

Investors keep trying to catch the turning point, only to be quickly shaken out when positive momentum fails to build. The main reason this happens is that they are more focused on nailing the exact bottom than on waiting for better technical conditions to develop.

A market bottom is a process, not a moment. It requires several steps, and it rarely looks like a V-shaped move in which stocks suddenly go straight up.

The first thing needed to signal a bottom is some strong finishes. The dynamic we have currently is strong opens and weak closes. Good markets have the exact opposite behavior, with strength building during the day and a close near the highs.

A big gain with a strong finish would be the first step in a potential bottom, but even that is not enough. One-day bounces can quickly reverse. The next step is for the recent lows to hold for several days, followed by strong follow-through action. Follow-through is what confirms a potential new uptrend.

At this point, we have not even had the first step, yet we have the usual overly anticipatory traders trying to call the turn.

Since a bottom is a multi-step process, the only rational approach is to stay patient and wait for those steps to develop. If you have a shorter-term time frame, you can trade the volatility. My call that the opening strength would not hold made for a quick fade trade on Monday.

What to Watch Tuesday

We will see if the market does a better job of holding on to strength Tuesday. A solid close on good volume would be one step away from the current misery, but it is going to take more than that before we can be confident that a new uptrend is developing.

Work on those shopping lists and make sure you identify some potential buys. It is too early to hit the buy button, but be ready.

Is this a bounce or a bottom and how should we play it? pic.twitter.com/EaX64uvQm1
— James DePorre (@RevShark)