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A Big Problem For The Stock Market

Exposure Status: Risk Off

OVERVIEW
Something Is Bound To Break

Source: S&P Capital

Good morning, Swingly traders.

Recently, the stock market's strong performance has been driven mainly by just a few stocks, like Apple, Nvidia, and Microsoft, which is causing concern. If you look at the chart above comparing the S&P 500 with an equal-weighted version of the index and the S&P 600 Small Caps, you'll see that the average stock has been significantly underperforming in recent months.

You've probably noticed this in your own trading. Most new long positions have likely resulted in getting stopped out, with losses piling up—unless those positions were in a select few AI-related megacaps.

Source: Stockcharts.com

What does this mean?

This divergence is becoming extremely pronounced. Take the Nasdaq Composite, for example. It's hitting all-time highs, but the percentage of stocks above their key daily exponential moving averages is dropping:

  • 28% of stocks are above the daily 20-EMA

  • 35% of stocks are above the daily 50-EMA

  • 36% of stocks are above the daily 150-EMA

  • 40% of stocks are above the daily 200-EMA

This situation is clearly unsustainable and raises a critical question: how long can this narrow leadership continue before the broader market catches up or corrects?

We're still not sure how worried we should be about this situation. We're in a favorable environment for stocks: the economy is growing, earnings are rising, and inflation seems to be falling again, which could lead to the central bank lowering interest rates soon. Despite the last month's performance, it's important to remember that over the past 15 months, while the average stock has lagged behind big tech, it has still done quite well overall, with an annualized real return of eight to nine percent, above the historical average, especially when you include dividends. It's reasonable to question if Nvidia and other big tech stocks can keep up their impressive performance, but it's too early to say the rest of the market is in trouble.

Sure, a spike in inflation or a drop in consumer spending could shake things up, but that would be a concern even if the market was less focused on a few big names.

Interestingly, we could argue that the high concentration means the average stock is due for a comeback.

Nasdaq

QQQ VRVP Daily Chart

As we've discussed, the Nasdaq keeps hitting all-time highs with little to no resistance. The visible range volume profile (VRVP) is showing increased selling pressure as the QQQ climbs past $474, but this hasn't done much to slow the index down.

In the immediate short term, we might see the QQQ start trading sideways or even dip a bit to allow its daily 10-EMA to catch up, as it seems a bit extended right now. This is especially true given the higher selling volume at these new highs. However, much of this will depend on Nvidia, Microsoft, Apple, and the other major megacaps, which don't seem to be slowing down at all.

S&P Midcap 400

MDY VRVP Daily Chart

The midcaps broke down below their rising support level, which had been holding since December 2023. This is a clear sign of weakness, especially when combined with the increased volume during Friday’s trading session.

We did see a doji candle, which is promising and indicates that there was some demand trying to counter the selling pressure. However, our confidence is low since the MDY has underperformed for the past month, struggling to break out of its descending channel since mid-May.

Ideally, we want to see the MDY climb back up towards its point of control (POC) at $536 and fill the gap just above it. We remain optimistic because the index is extremely oversold, and a relief rally is overdue. However, we must remember that things can stay oversold for quite a while.

Russell 2000

IWM VRVP Daily Chart

What immediately catches our attention is the dramatic action in the IWM over the last three trading sessions. Notice the spike in selling pressure following Wednesday's inflation data, which triggered a three-day decline of nearly 5% as soon as small caps touched and were rejected at the $207 resistance zone. Similarly, their POC at $205.40 saw almost no demand stepping in to support the Russell 2000.

It's incredibly clear that small caps are struggling. Logic would suggest that with a strengthening economy and improving inflation data, the equities market, especially the smaller and more speculative names, would begin to improve. However, that's not what we're seeing right now.

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DAILY FOCUS
Not The Right Time To Trade

The average stock is either declining or stuck in a sideways pattern. The likelihood of a breakout or significant upward move is low right now. It's not impossible, but it's not probable.

As traders who prioritize probability, our decisions hinge on the question: "What is more likely to happen?"

If you open a naked long position today, the most probable outcome is getting stopped out the same day without the trade working in your favor. That's why we're maintaining a risk-off stance.

Currently, our positions include several stocks and a 3x leveraged NVDA ETF, which has significantly boosted our returns and kept our portfolio at peak equity. We don't see any reason to go against this bearish market trend.

WATCHLIST
The Leaders

NVDA: NVIDIA Corporation

NVDA Daily Chart

  • Nvidia continues to achieve remarkable gains, significantly outperforming every other stock in the market.

  • We increased our position a few days ago based on its daily volatility contraction pattern (VCP), and we haven't seen any signs of Nvidia weakening.

  • Today, we might see some sideways movement, considering how extended the stock is above its daily 10-EMA. However, Nvidia has yet to close below this level, which would prompt us to consider taking profits.

SMCI: Super Micro Computer, Inc

SMCI Daily Chart

  • SMCI broke out during Thursday's session and formed a doji candle on Friday as it consolidated above its daily EMAs, digesting the significant volume breakout from Thursday.

  • We currently hold SMCI, and we're watching closely for a break above the descending resistance level at $870. If it breaks above this level, we'll consider adding more long exposure to our position.

This newsletter does not provide financial advice. It is intended solely for educational purposes and does not constitute investment advice or a recommendation to trade assets or make financial decisions. Please exercise caution and conduct your own research.

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