What to Watch Next for This Rally

Days like today remind me of a joke told by Mark Twain...

An old prospector dies and finds himself at the pearly gates of heaven. But there's a crowd of other prospectors in front, all pushing to get their moment with St. Peter so he can check off their names and let them in.

The old prospector has an idea.

Suddenly he yells "Gold discovered in Hell!"

In an instant, the other prospectors rush off to check out the tip.

St. Peter, impressed, gestures to the pearly gates. "That was mighty clever. Go on in."

The old prospector shakes his head. "No, I think I'll stay out here a while," and starts walking away.

"Where are you going now?" asks St. Peter.

The prospector smiles over his shoulder and says "I'm going down to Hell. There just might be something to that rumor after all."

Mark Twain told the joke better than me, I'm sure.

But the point being, it's hard to stand alone among stampeding investors for any reason - real or fake - and not feel the strong urge to join the herd.

So now that the Federal Reserve has decided to taper its bond purchases, the stock market responded with a demonstration of animal spirits, pushing all the major indexes to new all-time highs.

Even the small-cap Russell 2000 index has finally gotten in on the act, breaking above its trading range of the past 11 months.

It hardly seems like the environment for a market top, as I've been loudly cautioning in the last few weeks, right?

Watch for Futures-Driven "Pop & Drop"

So yes, I could be wrong.

Perhaps this really is the beginning of a stock market melt-up instead of the end of one.

I've certainly enjoyed it with my own personal portfolio in recent days. The goodBUYs portfolio has likewise jumped a couple of percentage points over the last week or so.

So if the market keeps roaring higher, I won't complain.

But Wall Street trading houses have billions of dollars at stake as they move in and out of the market.

So they sometimes use the overnight S&P 50 futures market to help push the stock market to open sharply higher - or sharply lower - when it suits their purpose.

That's what I'll be looking - a futures-driven "pop and drop" in the stock market.

(I used to spend a lot of time trading S&P 500 futures contracts myself years ago  -electronically, from home. Made some nice money too.

But when my son was born, I had to give it up. I just couldn't stay in front of a trading screen the way I did before. Inevitably I'd need to help my wife change a diaper or warm up a bottom of formula, and then I'd miss the trade I was waiting for!)

I saw this pop-and-drop trading tactic many many times:

See, the big Wall Street trading houses can't unload large blocks of stock unless they have someone else on the other side that's just as eager - or more so - to buy and take it off their hands.

So these big institutions sometimes "engineer" just such a situation.

When the market is at or near its highs, the firms' traders will start buying S&P 500 futures contracts in the evening, after the stock market is closed, on the Chicago Mercantile Exchange's overnight electronic trading session.

The traders keep buying contracts all through the following morning.

The result, of course, is a huge rally in the price of the S&P 500 futures contract.

The next morning, stock traders like you and I wake up, check the market before the opening bell and see that it's going to open 1% or 2% or 3% higher and think "Today's going to be a great day!" and get into a super-bullish frame of mind.

In the process, we become the collective buyers of all those big blocks of stock that Wall Street firms want to unload without hurting the price too much.

That's how market peaks are formed and retail traders like us are left holding the bag.

So let's enjoy the rally, but stay alert for this kind of situation  - it could break either way in coming days.

Best of goodBUYs,

Jeff