Some People Are Reading This Market All Wrong

Last week, the Fed increased interest rates for the first time in three years, which helped take some uncertainty out of the market.

Everyone knew that a rate rise was on the way… the Fed had been forewarning the market about it for months…

They just didn’t know how big that increase would be.

But, with the rate rise locked in (up 0.25%), plus some positive words from Fed Chairman Jerome Powell about the economy, we saw a sharp relief rally get underway.

Stocks like Amazon (AMZN), Tesla (TSLA), and Apple (AAPL) all had big weeks, leading to a 12% gain in the Nasdaq.

Yesterday, I discussed how Tesla rose 30% in just six trading days… the type of stock (high growth, high P/E ratio) that should suffer from an increase in interest rates.

After failing to create lower lows over the previous few weeks – despite all the bad news everywhere – the market was looking for a reason to rally.

Now, over a week after that relief rally began, traders are again confused about the strength of this emerging rally.

That’s why I’ve been emphasizing all week about the need to understand (and follow) key technical indicators like the Relative Strength Index (RSI).

Rather than blindly jumping onto anything that’s rallying, we’ll use the RSI to see what’s happening behind the price action and whether buying momentum is gathering or losing steam.

The last thing we want to do in this market is buy into something in the hope of a big rally, only for it to quickly reverse and decline. Doing so is a sure-fire way to tear a hole in your trading account.

However, while understanding momentum helps avoid jumping onto a dud rally, it also offers something critical to this market environment – the ability to help pick reversals.

When the RSI forms an inverse ‘V’ and begins heading lower, it can often be the perfect setup for a short trade.

Meaning, we can have more confidence selling into rallies… That’s something traders should get used to this year.

You see, some folks don’t seem to grasp that the market has changed. After a nearly two-year solid uptrend, the market is now trying to establish its next direction.

While the major indices all formed a base these past few weeks – with some calling that base the bottom – there’s still no guarantee that the market has found long-term support… Odds are, it’ll likely test it again.

That means that the market is going to keep zigzagging. People who think that it’ll rally all the way back up to its December highs will be sorely disappointed.

We must remember that last week’s rate rise was just the first of many similar rate rises to come.

With the Fed so far behind the curve, it’ll need to raise rates more quickly than it wants to get a handle on inflation.

So, it’s becoming much more likely that the Fed will raise rates by 0.5% in the next month.

It’s certainly possible that we’ll see short, sharp rallies caused by strong jobs numbers or a low unemployment rate. But it’s important to remember that prolonged interest rate rises will still hang over the market’s head.

And that’s going to put a cap on any rally…

Given this scenario – unless the next earnings season surprises massively to the upside – I just can’t see what’s going to drive the market higher long-term.

Meaning, unlike the last two years, investors can’t simply buy the dip and hang on for the ride…

Instead, we need to sit patiently on the sidelines and be ready to pick off any trades (in either direction) that come our way.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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