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The Market Flashing Warning Signs 🚨

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Exposure Status: Moderate Risk

OVERVIEW
Nothing Good Ever Happens Below the 20-EMA

After last week's rally to new all-time highs, the market has hit pause, with several short-term concerns bubbling up. In the next few weeks, we’re facing a perfect storm of major events – big tech earnings, the October payrolls report, the U.S. election, and the Fed meeting – all crammed into a short timeframe. It’s the kind of lineup that could easily stir up some serious volatility.

While there may be more ups and downs ahead as we move through earnings season and inch closer to the November election, the bigger picture still looks strong. This week’s dip serves as a reminder that even the best trends take breathers. Whether this is just some pre-election nerves or the start of something bigger, we’re keeping an eye on the potential for more downside in the coming weeks.

VIX Daily Chart

The Volatility Index (VIX), one of our key indicators for assessing market sentiment, is still holding above its 50-EMA, signaling some caution. Given the inverse relationship between the VIX and the S&P 500, this pattern of higher lows and staying above key moving averages suggests that uncertainty is building, despite the VIX tightening below its 10- and 20-EMAs.

Right now, the market is entering a tricky phase. Pre-election jitters are nothing new, but when combined with weakening breadth over the past week, it points to what looks like a healthy pullback after an extended uptrend. On one hand, this is typical market behavior.

On the other hand, some of the biggest earnings reports of the year are about to drop on October 30th and 31st. These reports could have a major impact on where the market goes from here, especially with the election so close. The results from these tech giants will be crucial in shaping the market’s direction and investor sentiment. With several companies boasting market caps over $1 trillion, and many others worth hundreds of billions, these earnings are nothing to overlook. The reaction to these results could drive the market's next big move, setting the tone for the weeks & months ahead.

So, how do you play this?

That’s a tricky question, and it really depends on your risk tolerance. In the broader context of swing trading, you generally want to avoid buying long positions when the market is distributing after an extended rally; that’s usually when short positions make more sense.

However, this earnings season feels a bit different. While opening long positions in random stocks that are falling might seem like a low-probability play, the reality is that major earnings reports could change the game. For instance, Tesla is gapping up in premarket trading on a positive earnings reaction, and over the next week, we’ll see big names like Amazon, Apple, and Microsoft reporting their earnings as well. If these companies respond positively, they can drive the market higher, regardless of how weak the overall indices look or how poor the market breadth may seem. That’s just the nature of how these megacaps influence the broader market.

We’ll dive into our specific playbook for today shortly, but first, let’s take a moment to break down the three major capitalization groups. This will give us a clearer understanding of the current market landscape and how different segments are behaving:

Nasdaq:

QQQ VRVP Daily Chart

The Nasdaq faced a setback yesterday, breaking down from its volatility contraction pattern (VCP) that had been forming along the rising 10-EMA. It even tested the point of control (POC) level around $482, leading to the QQQ losing its 20-EMA.

However, demand quickly came back in, pushing the Nasdaq above the rising 20-EMA during that intraday dip. This surge in buying, along with increased volume, is a positive sign. It indicates that buyers were active in preventing a further decline, showcasing resilience despite the market's challenges.

Right now, we’re observing a low-volume range on the QQQ between the rising 50-EMA and the POC level of $482, extending up to the top of the trading range, where overhead supply sits just below $500. We believe this zone will hold, and that the market will likely continue trading sideways for the time being, especially considering its reaction to the intraday dip.

Additionally, assuming the upcoming earnings reports are positive, major tech earnings released this week could provide a much-needed lift for the QQQ. While the immediate trend may seem negative, it’s hard to adopt a bearish stance on large tech stocks right now. Tests of the daily 20-EMA are quite normal during sustained uptrends, and this is far from a “sell-off” that should trigger fear.

S&P Midcap 400

MDY VRVP Daily Chart

Midcaps are feeling the pressure, which isn’t surprising given how sensitive smaller capitalization groups typically are during pullbacks. The MDY not only lost its 10-EMA but also its rising 20-EMA this week and is currently hanging onto a significant demand zone. We expect some sideways movement for the rest of the week in this area.

Looking at the visible range volume profile (VRVP), we can see a dense level of trading activity between $570 and the rising 50-EMA around $560. Notably, the volume was low during yesterday’s bounce off the 50-EMA, combined with a doji candle, suggesting that this isn’t a heavy sell-off accompanied by high volume that would indicate the start of a major pullback.

As we navigate through this, it’s crucial to take things one day at a time. The most important factor to monitor is the individual stocks on your daily watchlist, as they will provide a much clearer and more complete picture of the health of the U.S. equities market.

Russell 2000

IWM VRVP Daily Chart

The situation for small-cap stocks mirrors that of midcaps—they’re taking a significant hit, which is expected. However, small caps are flashing more serious warning signs compared to other groups. The point of control (POC) level at $222 has been acting as resistance for two consecutive sessions, leading to a breakdown toward their rising 50-EMA. This level is crucial to watch for any potential recovery, and given the dense volume range between $217 and $225—similar to the MDY—we’re likely to see some sideways movement here.

It’s essential to emphasize that the rising 50-EMA must continue to serve as support. Buyers need to defend this zone; if they fail to do so and the level is lost, we could see how little demand exists below $217. This could trigger a rather sharp sell-off if we start to break down below that level.

DAILY FOCUS
Let’s See If Tesla Attracts Demand

Big tech earnings season is officially here, and as we’ve mentioned, no matter how bearish we might feel about the overall market, trading is all about probabilities. For non-institutional traders like us, the key is to “follow the money.” Today, Tesla will be a significant test with its earnings, serving as an episodic pivot point. If big money steps in to accumulate this beaten-down stock, it could provide some relief not only for Tesla itself but also for the market as a whole.

This brings us to an important point about how we plan to position ourselves and manage risk moving forward. In a market that shows signs of distribution or weakening, our primary focus is always on preserving capital. With that in mind, we’ll be considering half or quarter-sized positions on strong names that gap up and demonstrate potential as episodic pivot candidates.

We treat episodic pivots differently from breakouts because EPs often mark significant turning points in a stock's overall trend. When a stock has been struggling for an extended period—whether that’s several months or even years—trading sideways or downwards, the only thing that can shift that momentum to the upside is a surprise. This surprise, something the market wasn’t expecting, can drastically change perceptions of that stock. Earnings reports are one of the highest-probability ways to capitalize on these pivotal moments.

WATCHLIST
The Pre-Market Gapper To Watch

TSLA: Tesla, Inc.

TSLA VRVP Daily Chart

  • Today, TSLA will be our main focus, and we’ll be closely monitoring how the 5-minute opening range high plays out. The stock is currently gapping up above its declining 10-, 20-, and 50-EMAs into a relatively dense zone of overhead supply between $238 and $250, which could present challenges for a sustained breakout.

  • This is precisely why we’re keeping a close eye on TSLA. If we see buyers push through and follow up on the 5-minute opening range high with a breakout, it could be a strong indicator that the pullback in large tech stocks may not last as long as many expect.

  • However, if the 5-minute opening range high is taken out and we trigger long exposure, we’ll do so with significantly reduced risk (0.25% of NAV). Given the current market climate, there’s a lower probability of follow-through, especially with the overhead supply weighing on Tesla. So, we’ll be cautious and strategic in our approach.

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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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