As U.S. markets remain in exceptionally overbought territory, the prospect of a pullback appeared near after the close on Thursday. The possibility of a pullback was created by ongoing overbought conditions. But the pretense of a potential pullback was the announcement that the Federal Reserve had decided unanimously to raise the discount rate to 0.75%.
The immediate reaction in the market was to sell and sell swiftly. Within a few hours of the announcement, the S&P futures were off by 1%.
But with the markets opening on Friday, cooler heads have prevailed and the overbought conditions we ended the day with on Thursday are the same overbought conditions we will see as trading begins on Friday.
As I wrote in a piece for Forbes.com last night, rate cut + sell-off = high probability opportunity. If you were watching the markets or the financial media yesterday after the Fed’s announcement, ask yourself how you felt when you heard the news. If your first (or maybe second) thought was, “Now we’ve got a reason to finally pullback,” then congratulations, you are thinking like a high probability trader.
Unfortunately, overbought conditions mean that there are relatively few top rated exchange-traded funds in the ETF market right now. There are no ETFs with ETF PowerRatings of 10, 9, 8 or even 7. The short side right now offers no more opportunity, with only one exchange-traded fund, the ^PBW^ earning an ETF PowerRating of less than 3.
Aside from potential opportunities in inverse leveraged ETFs (click here to read yesterday’s discussion of trading leveraged ETFs in a market that is running away to the upside), now is a time for high probability traders to wait patiently for the biggest and best edges to develop. Just because the markets appear to have shrugged off news of the Fed discount rate increase does not mean that overbought conditions have gone away. There is still profit-taking to be done in this market and when that profit-taking arrives, high probability trading opportunities will likely not be far behind.
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David Penn is Editor in Chief at TradingMarkets.com.