"Hello, friends." - (said in my best Jim Nantz impression)
It's Masters Sunday, my favorite day of the year! While we're stuffing ourselves with Pimento Cheese Sandwiches and watching the world's best play golf, it's time to start thinking about the trading week ahead. Due to the Iran/Israel escalation this weekend, I think we have a very interesting week on deck. I'd like to start this week's Market Prep a little differently by spending a few moments discussing the marriage between market psychology and market positioning in order to develop a mental framework to make decisions this week.
Whenever we get a legitimate market-moving catalyst (such as a major military conflict), I often spend time thinking through the psychological aspects of positioning in order to recognize which hypothetical scenario is actually playing out so I can trade accordingly. Newer traders often get hurt thinking too simplistically about major catalysts, and having a few scenarios in your back pocket can save you a lot of headaches. For example, it's logical to assume the stock market would tank in a war-time scenario as people panic; however, the last few years has taught us that sentiment/positioning often matter more than what should happen,
Based on the rather violent sell-off in crypto after the Iran/Israel news, let's start with the most "obvious" scenario for the week: A fear driven sell-off.
SCENARIO 1: Proper Sell-Off
Given the plethora of options exposure at SPX 5000, we can consider Scenario 1 our "base case" reaction to the weekend news due to its simplicity and logic. But, as traders, we know the market rarely does the "logical" thing, so let's consider a couple other scenarios before we get too bearish.
SCENARIO 2: HedgeFest 2024
Scenario 2 strikes me as more realistic due to well-established market mechanics: If everyone's hedged for the same scenario, it's unlikely to happen. This second scenario essentially involves a Sunday/Monday Gap Down, a rush to Put Options (causing more downside), then a stabilization after everyone's hedged. This scenario has played out many, many times in recent years and if we see any signs of stabilization midweek it's the scenario I'd consider most likely.
SCENARIO 3: The Unexpected Bear Thrasher
Friday was technically the last day to reposition your portfolio before filing your taxes, so in this scenario we're leaving the door open for the possibility that Friday's bloodshed had a distinct root-cause and the bull-run will continue, mystifying bears with wild green candles despite global uncertainty. As much as I hate this scenario, I really don't think we should rule it out considering the very strong uptrend the market has been in for many months.
Now that we've established 3 scenarios for the week that I consider the most likely, let's dive into some charts to find a Weekly Pivot for ourselves to trade around.
Starting with the S&P500 (SPX) on Daily Candles, we can see the critical juncture price has reached: We've lost the major trendline going back to the DotCom Bubble highs and price closed very near the 50 Daily Moving Average (DMA). The S&P500 has not interacted with the 50DMA since November of 2023, so if you're a swing trader this is now an important natural pivot point in the market, but for the day traders I think there's a better pivot for the week...
We've already established the 50DMA on SPX is right below price, so if we get Scenario 3 this week and bounce upward from the 50DMA, the real test will be if price can climb above last week's midpoint (5217.50 ES) and the Red Support/Resistance line shown above. Therefore, I'll be using ES 5217.50 as my Weekly Pivot this week, favoring long trades above and short trades below.
If we happen to get Scenario 1 this week and actually sell-off, my Trusty Ol' SPY Model has me watching SPY 500 again early in the week, and SPY 505 by Friday (a Friday bid to 505 would represent Scenario 2 playing out).
One of the things I'll be watching closely on Monday is the activity in the Put/Call Ratio in order to get any clues about which Scenario is likely playing out. Currently, the market remains relatively poorly hedged (all things considered), so I will not be shocked if the P/C Ratio skyrockets Monday/Tuesday. If it somehow gets over 1.27 I will have to assume Scenario 2 is likely to play out.
Obviously it's worth watching the largest megacap names this week. The Nasdaq (shown above, Daily Candles) is currently sitting very near its 50DMA and the top of a channel. I was using 18200 as an NQ Pivot last week and plan to do the same this week, recognizing 18000 as another natural psychological pivot for traders....if the market loses that level I think the door is open for real downside towards the 200DMA at 17000.
In terms of individual plays this week, I don't have much for you because I'm still letting some of my current positions (see: prior Market Preps) play out, but I am interested in shorting XLF considering Bank earnings have begun and we're likely to get higher volume in the ETF. For this scenario, there's not a lot of meat on the bone left but if I can catch XLF from $40 down to $38 via Options I'd be happy with that tactical trade. The daily candle chart above supports that move, but the problem is the market may price this in immediately come Monday morning if we get a serious reaction to Iran/Israel. In that case, I will have missed the trade.
Whatever you do this week, please do it carefully. We've had a few of these situations where military conflict has escalated but the market completely ignored it so I have no way of knowing when the market will finally react, but as a trader I find it helpful to brainstorm different scenarios in order to have that "Ah Ha" Moment during the trading week when I recognize what large participants are doing with their thinking/positioning. Sometimes we can't figure it out, but for those rare times we can decipher the market narrative the brainstorming pays for itself as we ride the coattails of the larger players.
It's worth mentioning that I fully expect Gold and Oil to be extremely volatile trading vehicles this week; I wanted to write about them here but I honestly think the risk isn't worth it. Will Gold and Oil be moving early this week? Absolutely, but I fear the volatility will render my typical technical analysis rather worthless considering we're dealing with a fear-based situation. There are some trading situations were doing nothing can be more profitable than gambling. If I touch either of those commodities it'll be in small size. Tread carefully this week!
Sending all the positivity I have to the families/civilians impacted by the current conflicts,
Horse