Published on February 16, 2014
The S&P 500 rose the other day. Investors and traders seem to believe that the US economy is strong enough to withstand further reductions in the US Federal Reserve’s monthly bond purchases.
The so called quantitative easing program is largely credited with keeping the economy afloat during the worst days of the recession and in helping to stimulate a continuing recovery.
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But, the markets worried that when the $85 Billion a month bond purchases dried up, so would the economy.
Many now believe that as the Fed continues to cut back on its monthly bond purchases that the economy will survive and prosper.
And as a result the S&P 500 which is a bellwether of the US economy went back up as well.
Our concern is how traders can mix sound technical analysis with the S&P 500 as a guide to trading.
The Chicken or the Egg and Following the Herd
Which comes first, the fundamentals that drive up stock prices or the anticipation of those fundamentals?
Often times long term investors follow the herd.
That is to say, when the S&P 500 rises investors who have been on the sidelines decide to jump into the market.
This increase in buyers drives up prices. And, when too much buying occurs, prices drop back down.
Good quarterly financials drive up the stocks in the S&P 500.
The news of the S&P 500 rise drags more buyers into the market.
Contrarian trading tells us to let the herd make its move and then wait for the fundamental and technical signals that predict a turnaround.
In this sense one can use the S&P 500 as a guide to trading by looking for when it overshoots its mark, either on the up or down side.
Combining the S&P 500 as a Guide to Trading with Other Factors
You do not always need to wait for the S&P to over shoot in order to make a profit trading stocks.
Sometimes in the early stages of a prolonged rally there is very low trading volume despite the presence of sound fundamentals.
This may be the case in the current circumstance.
The S&P 500 went up to near its all-time high in fairly light trading volume.
When the S&P rose it did so in a market in which only 6 million shares were traded.
Many strong long term rallies start just like this.
The Loss of One is the Gain of Another
Not all of the good signs in the S&P 500 as a guide to trading are the result of factors in US markets.
China seems set to a big economic hiccup and other emerging market economies are set to follow suit.
As a result, money is flowing into the USA.
So long as things are getting worse elsewhere the S&P will likely keep rising.
But, when using the S&P 500 as a guide to trading remember that the US markets can only absorb so much investment capital before it starts to flow the other way.
This brings us back to the contrarian approach to day trading, which is often the most profitable!
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