Markets go three ways – up – down – sideways. No need to state the obvious that recently the move has been up. The choices from here are still the same – up, down or sideways. What is more likely?

Many punters in the US are still betting there is more upside and they will attempt to push the market higher. But the more they do that, the more they will find willing sellers who will more than satisfy any seemingly insatiable appetite they might have. But eventually they will get their fill and they also will withdraw from the market as the pain of buying with the stock only to fall some days later becomes too much too tolerate for even the most cavalier. Thus the probability of the market rising further in the immediate term is not high.

Will the market fall? That is a possibility and a probability but there are also many reluctant sellers out there. Over the last week there has been a little nervousness creep in and it is now a matter of waiting and watching to see if that lack of nerve escalates. If the markets do fall then the big question is whether that becomes retracement or an actual decline that could actually find new lows – a frightening thought for some. There are still a large number of highly respected analysts who have seen many cycles that have the view that this run could “end in tears”. If that view is even given a little more credence then a retracement will gain momentum.

The level of option “put” activity in the USA is still relatively low compared with “call” activity which indicates there is no real nervousness at the moment. In fact the so called fear index – the VIX – shows Americans are very comfortable with where the markets are at right now.

The weakest link I see - technically is the S&P 500. Note in the chart below how momentum (using Video Series Software) has been in decline since May end with the index having traded sideways for most of May, June and July.

click chart for more detail

So if the S&P weakened, will that affect the DOW and in turn the XAO? Yes most likely – there is without doubt a domino effect phenomena evident in the markets. So maybe the S&P is the first one to crack or maybe the third option takes hold. That is, the markets track sideways until there is reason to push them higher or lower. For them to go higher there will need to be overwhelming good economic news which seems most unlikely in the near weeks and months as so much good news has been factored in.

One can only observe the trading pattern – not fight it – but at least be aware of what are the more probable scenarios. From my own trading perspective I am inclined to think there will be some element of range trading with a tendency to the downside. In the back of the minds of most Americans is the dreaded thought that September is traditionally a freaky month and whilst they will be happy to see the back end of the month there is still that lurking possibility that this year the “X” factor has been held at bay – but maybe only for a while.

Even with the market indecision there will still be good opportunities, so my strategy will be to “selectively” buy shares in the Australian market and to hedge using options in the USA. That way I feel much more secure than when I used to depend solely on buying shares and being helpless when the markets were going in the two directions I did not want – sideways or downwards. Being master of my own destiny is important to me!

Enjoy the ride.

Tom Scollon