In last week’s update, I discussed the short-term oversold condition that existed at that time. To wit:
“As you can see, the markets did retest the late August lows, and when combined with the very oversold conditions, led to a frantic “short covering” rally back to previous resistance. It is worth noting that the recent market action is very similar to that of the August decline and initial rebound as well.
Of course, the question that must be answered is whether we have seen the end of the current correction or is this just another “reflexive rally” that will fail?”
The chart below is updated through yesterday’s close.
Click on image to enlarge
Currently, the bulls have clearly been in charge of the market. The question is for “how long?”
While last week’s FOMC minutes gave the “bulls” some confidence that the Federal Reserve is not removing its accommodative policy, it was the massive amount of short-interest (people betting on markets to fall) that provided the fuel.
Click on image to enlarge
The chart above, from ZeroHedge, shows the massive jump in short-interest that has to be covered as stock prices rise. When players are “short the market,” bullish reversals in prices force traders to close out their positions by “buying” into the market. This fuels additional buying, which pushes prices higher, which forces more players to close out their short positions. This cycle continues until the “fuel” is exhausted. This is why market rebounds tend to be extremely sharp and fast, but also fade just as quickly.
For a visualization think about the “Whoosh Bottle” where an air/gas mixture is fairly inert until ignited by a catalyst. (Vine by @scienceporn)
That mixture of oversold market conditions, combined with a sharp rise in “short interest” in the market, was the perfect accelerant waiting on a match. That match was the Fed failing to hike rates and a lack of China in the headlines.
Leave A Comment