Here’s the real reason behind Dow 21,000 (no, it’s not Trump’s speech)

Published: Mar 2, 2017 3:31 a.m. ET

As I write this, the Dow Jones Industrial Average DJIA, -0.27%  has surged more than 300 points, vaulting the benchmark index over 21,000 points for the first time. This ferocious rally, a day after President Trump’s speech to Congress, also is reflected in other indices, including the S&P 500 Index SPX, -0.41%  and the Nasdaq 100 NDX, -0.42%

Stock market gurus are out in full force explaining the reasons for the rally. But I have not heard the real reason from a single person.

To get to the answer, let’s start by reviewing an annotated chart of DJIA futures.

To find out what happened today, we’d have to know how large players were positioned going into Trump’s speech, which took place after the close of the stock market. (Positioning, in this context, means aggressive short selling or buying prior to the speech.) These players figured that the Trump rally, which has stretched on for months, has been based on hope and that, unless the president gave details about plans for the economy, there would be a big selloff. They reasoned that, by looking at past speeches of presidents before Congress, the details are almost never there. So it appeared a perfect setup to short sell; in other words, to bet on a decline in share prices. According to algorithms at The Arora Report, these players built substantial short positions, as shown on the chart.

Short sellers tend to be the nervous type prone to panicking easily. They do so for good reason: In short selling, losses can be unlimited.

After Trump’s speech, when the market did not fall, the short sellers were forced to cover their positions, thus driving up share prices. (The initial so-called short squeeze and its progression are shown on the chart.) This forced-buying made futures run up prior to the 9:30 a.m. start of trading in New York. When the stock market “gapped up” at the open, computers and their algorithms took over and bought aggressively. That triggered other algorithms, exaggerating the move. Thus, that was interpreted as a confirmation of how good Trump’s speech was.

The talking heads on TV were quick to say that the stock market was rising because Trump was conciliatory in his speech. What happened to those same talking heads’ pronouncements a day earlier that the market would fall if Trump failed to mention specifics of his economic plans?

You see, most talking heads don’t have skin in the game. They don’t trade with their own money and, thus, stay oblivious to market mechanics. Their profession is not trading, but talking, and what is better than talking from both sides of one’s mouth? That way, they are always “right.”

According to algorithms at The Arora Report, about three-quarters of the increase in stock prices today is from short squeezes. Historically, runs based on short squeezes arising out of positioning from an overbought market tend to reverse themselves. For that reason, as hard as it is, it is prudent to be patient and wait for pullbacks to buy stocks. There are reasons to be bullish. But, alas, the market is not likely to keep rising in a straight line.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. All recommended positions are reviewed daily at The Arora Report.

Nigam Arora is an investor, engineer and nuclear physicist by background, has founded two Inc. 500 fastest-growing companies, is the developer of the adaptive ZYX Global Multi Asset Allocation Model and the ZYX Change Method to profit from change in trading and investing. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.