OVERVIEW
Is The Looming Election Dragging Us Down?

Yesterday, we finally saw the pullback that was becoming quite overdue, with everything from small-cap (IWM) to large-cap indices (SPY) pushing down to their rising 10- Exponential Moving Averages (EMA). Even in the premarket today, the equal-weighted S&P 500 (RSP) is breaking down into its rising 20-EMA.

As we approach the upcoming Presidential election, historical trends suggest the market often experiences either a significant pullback or at least heightened volatility leading up to Election Day. Over the last six election cycles, the S&P 500 (SPX) has averaged a negative return of 4.3% during the two months leading up to the election period, with a median decline of 1.9%.

This trend isn’t just limited to large-cap stocks. Small- and mid-caps have also seen similar losses. Defensive sectors—like consumer staples, utilities, and healthcare—have historically outperformed, posting average relative gains of 3.9%, 3.4%, and 2.3%, respectively. Meanwhile, real estate and technology sectors have typically struggled, averaging relative declines of 3.5% and 3%.

Interestingly, we've seen the opposite of what's typically expected. Nvidia, the market leader, is making new highs after a continuation from its breakout on October 3rd, with several other tech stocks following suit. Meanwhile, financials and consumer defensive sectors, which usually lead during times of uncertainty, are actually pulling back.

This shift could be due to the market potentially pricing in a Donald Trump victory. His lead in online betting polls may have reduced the usual uncertainty surrounding such a major event.

Increased market volatility is also emerging, a typical trend in election years. For instance, in 2020, the VIX surged 44% in the two months before the election. Right now, the VIX is holding steady just below 20—nothing too alarming yet—but the bounce off its rising 50-EMA and push into the descending 10-EMA isn’t the trend we’d like to see.

It’s crucial to look at the broader picture. While the VIX alone isn’t enough to make big decisions, a breakout above its 10-EMA could bring more pain to the equity markets. However, the strength in leading stocks like Nvidia, Apple, and others across different sectors still signals a healthy market. So don’t panic or make rash moves—let your open positions guide you before making any major changes.

Let’s dive into the evaluation of each market capitalization group to see where the relative strength in the market currently lies.

Nasdaq

The Nasdaq continues to lead the market, driven by the strength of AI-related semiconductor and technology stocks, with AAPL and NVDA alone influencing nearly 10% of the QQQ's direction. A high tight flag (HTF) is forming on the QQQ, with the past week showing a narrow trading range as the index consolidates along its daily 10-EMA. The supply zone between $495 and $496 has created some resistance, leading to recent distribution.

Given QQQ's strength, it's unlikely that the ascending support level at the daily 10-EMA will break entirely. However, an intraday undercut and reclaim is possible, particularly if we see further breakdowns in the mega-cap giants.

The key focus for QQQ is demand. It needs to hold its current trading level and defend the 10-EMA. A concern is the lack of volume contraction during this price narrowing, which often signals an impending move. That said, the increased volume in yesterday's test of the daily 10-EMA is a positive sign. As long as the price withstands a breakdown, QQQ remains in what appears to be a bullish contraction holding pattern.

S&P Midcap 400

Midcaps are still showing an upward trend in the medium term. While it wasn’t ideal to see the MDY pull back sharply to its rising 10-EMA, demand did hold at the $577 level. However, in premarket trading today, MDY has broken down and is now testing its rising 20-EMA. Today’s session will likely be crucial in determining whether MDY can reclaim its short-term uptrend or if we’re headed for a more distributive phase, likely extending until the election is behind us.

The selling pressure around $585 was significant, and the Visible Range Volume Profile (VRVP) shows a high level of supply at that range. There is solid support down to $570, which, if the rising 20-EMA is lost, will likely be the point where MDY could hold.

Pullbacks are normal, especially given how well the market has performed in recent weeks, so this isn’t alarming or something that invalidates the bullish outlook. We’ll discuss this further in the Daily Focus section.

Russell 2000

Small caps are also breaking down and failed to hold their rising 10-EMA yesterday, with premarket action sending the IWM even lower to $221. The level of supply and demand in this range is extremely dense, making it completely normal to see significant chop here. The heightened volume during yesterday’s sell-off is characteristic of the beginning stages of a pullback.

The red box on the chart highlights a level we discussed several times last week. The IWM needs to see demand step in to maintain this level, which was a prior area of resistance that the Russell 2000 has struggled to break above since June 2024. Although there were three sessions where the IWM appeared to hold above this level, the profit-taking was too strong, leading to the pullback in small caps.

DAILY FOCUS
Diamonds Are Made Under Pressure

Pullbacks are an essential part of the trading landscape and can actually be your friend in the market. When indices retreat, it’s crucial to evaluate which stocks are holding up the best relative to others and identify the industry groups that are still leading. This process allows us to discover the true strength in the market, even when the broader trend appears to be in decline.

During uptrends, it can be challenging to pinpoint leaders as everything seems to be moving upward. However, when pullbacks occur, diamonds begin to shine through the rough, revealing the real winning stocks. This is the time to assess the relative strength of each stock, rather than flipping short or selling all your positions simply because the indices are pulling back.

Evaluate Each Stock on Its Own Merits

It's vital to treat each stock based on its individual momentum. Look at how it behaves relative to its moving averages and whether it’s managing to outperform the market. Stocks that maintain their strength during pullbacks can be excellent candidates for your watchlist, as they may be poised for significant moves once the market stabilizes.

For instance, we currently hold a large position in MSTR, which we initiated during its intraday breakout on September 19th. We’ve scaled up during the sustained uptrend the stock has shown. Throughout this period, while the broader market pulled back, many traders panicked and sold their shares, fearing that the stock would begin to “crash.” Unfortunately, this led them to miss out on what turned out to be an incredible winner.

MSTR is a perfect example of relative strength. When the market pulled back, MSTR also dipped to its rising 10-EMA but never closed below this level. In fact, after testing the 10-EMA, it saw a sharp rally in the very next session. That’s a clear signal that the stock is trying to tell us something.

Always trade the stock, not the market, and never let your opinion of the market dictate your actions. Initiating new positions right now can be tricky, so if you're considering doing so, it’s wise to reduce your position size—perhaps to half or a quarter of your usual risk level—since the trend may very well be changing.

However, if you are looking at positions in leading themes, don’t be afraid to test them, assuming they are part of the current market leaders. Right now, it's more important than ever to apply any type of naked exposure only if there's a solid story or theme in the market; otherwise, you could be standing in the way of a tsunami.

Our approach today is defensive. We are not actively seeking new risks and will closely monitor the performance of our open positions, looking to take some profits off the table if we see any signs of weakness unfolding.

Note:

If you want to stay ahead of the leading market themes and see how our team is managing their positions, click here.

There’s no watchlist published today because we’re not specifically targeting any stock entries at this time. Our plan for the foreseeable future is to run scans to identify the relative strength leaders during what seems to be a forming pullback. We'll be asking ourselves the following questions and creating a separate watchlist of stocks that are holding up the best against this negative trend:

• Which stocks are trading above their 10-EMA and 20-EMA while their peers decline?

• Which stocks continue to see follow-through in their breakouts?

• Which sub-market groups and themes are leading?

• Which stocks that were the momentum leaders in the last 1, 3 & 6 month period are forming bases during the market downturn?

The stocks that best meet the criteria above will be the ones we actively watch for setups, as these are often the names that lead us out of a pullback and become. the market leaders in the next cycle. We always prioritize these stocks for potential entries.