Hello members!
We are now firmly entrenched in a very unhealthy trading environment for position traders. The market was very oversold and stretched to the downside and it looks like we are now in the midst of a potentially vicious squeeze to the upside.
The key to long-term survival though, is to keep things in perspective. Two important questions to ask are the following ones:
- Under what circumstances does a move take place?
- Do I have the appropriate skill set to trade that specific move?
The first question refers to ‘context’. Odds are that the current up move is nothing more than a counter trend bounce within a confirmed downtrend. The problem is twofold. First of all, we do not have proper bullish set-ups i.e. breakouts from low volatility patterns that have built up proper pattern pressure. Secondly, we have no way of knowing how long this counter trend move will last and how far it will go before the market faces renewed serious selling pressure.
The second question refers to something I would label ‘patience’ or ‘honest self-assessment’. The way I view my job as a trader is very simple: I do have certain strengths and there are times when the market environment is conducive to my trading style. When the stars are aligned I tend to go for the throat. When I see red flags everywhere and when trading is ‘not easy’ I simply step aside. I cannot control what the market does, cannot control the outcome of individual trades. What I do have control over is if I deploy capital or if I don’t. The current market conditions are the worst possible for position traders. Extreme volatility and failed breakouts are all over the place. As they say: “Patience is a virtue”.
Let’s get into more detail why I believe the odds for the recent low to be ‘the’ low are very slim. Here’s a list of my biggest concerns:
- This is the 2nd huge selling wave within 5 months. We are already trading back at the August and September lows of 2015. This could be a mid to long-term topping process where institutions use every rally to unload positions. The slower long-term moving averages like the MA 200 are now pointing down. We are now witnessing ‘bearish moving average expansion’ which can be seen at the beginning of a new bearish trend. Combine that with price trading below all those moving averages and you have a typical situation where ‘surprise moves tend to be to the downside’.
- Selling pressure has been brutal. We recently had several reversal candles and attempts to move higher over the course of the month. Still, we went lower. A case of ‘overbought can get more overbought’. The real issue at hand here is with individual stocks. They can get hit with selling pressure seemingly coming out of nowhere.
- Typically important lows are retested. So even if the recent low ends up being ‘the low’ of the current move to the downside, a lot of backing and filling and eventually a retest of that low should be expected.
- Utilities are leading. That’s what I would call ‘wrong leadership’. Defensive names are leading, the complete opposite of market environments providing huge gains. The biggest winners typically emerge during bull markets and are mostly growth stocks. We are not seeing that right now.
- We are in a counter trend / bounce trade environment. Something to take note of, is the fact that strong stocks do not perform as well as one would expect during those bounces. It is the most oversold ones that put in the highest percentage moves to the upside. This is typical bear market behaviour.
Conclusion: This market is extremely treacherous. Overall the market still only offers marginal trades. For position traders excellent bullish set-ups simply aren’t to be found anywhere. Strong stocks are struggling and weak stocks are a mixed bag. The best thing to do, is still to stay in cash until more strong stocks set up and replace defensive names leadership. Remember: The goal is to have maximum exposure during healthy market conditions and almost no exposure during extremely difficult market conditions.
Let’s move on to a valuable lesson the current bear market action has provided so far. Here’s a Case Study of ALKS – Alkermes that exemplifies two things I have been preaching for years now:
- Trading 52 week highs or all time high stocks provides the best protection.
- Apply simple technical rules and you avoid being destroyed by a losing stock.
Click on ALKS – Alkermes chart to enlarge:
The interesting thing about ALKS is that I actually owned the stock after it had put in the bullish white candle in December. The stock went immediately against me after I bought. It struggled immensely to come back and made me extremely nervous from the very moment I had bought it. Volume was not pumping. There was no follow through to the upside and it truly felt like sellers were in control although from a purely technical perspective almost everything was looking rather constructive.
This brings us to the first point I mentioned above. When you buy 52 week or all time high stocks, you are buying the best insurance the market has to offer. Why is that so? Look at the chart annotations. Bad things usually only happen under certain conditions. You get lots of warning signs prior to catastrophic events. I always listen to the charts and ended up selling ALKS for a break even trade. Little did I know of what was to come after I sold. I simply heeded the warning signals and stepped aside. The stock gave me enough time to get out unscathed because it was trading above all its moving averages.
Lesson: Listen to the charts. Learn to read them. Trust them. They provide information about the odds of good or bad things that are about to happen. Jesse Livermore’s following quote captures the essence of the ALKS case study:
Everything you need to know is right there in front of you. – Jesse Livermore
More timeless wisdom that describes the ALKS situation equally well would be Paul Tudor Jones’ belief that:
Price precedes news. – Paul Tudor Jones
For some broader perspective, here’s an analysis of the S&P 500 with clearly visible gaps and potential target areas.
Click on S&P 500 chart to enlarge:
The chart obviously shows how bearish the overall context is. We are just starting to see bearish moving average expansion. In such a situation renewed selling can hit anytime. It is important to keep in mind that for now the bears are in control.
The best looking chart I can find right now is RDCM – Radcom. Again, the problem is the fact we are in a market environment that typically doesn’t produce huge winners. There will be exceptions, but it is like swimming upstream. As I said, strong stocks do provide protection, but the overall market right now is not conducive to extremely aggressive trading.
Click on RDCM – Radcom chart to enlarge:
Watch List: Of course, no matter how bad a market looks like, I always do my scanning and maintain my watch list to make sure it contains the best stocks the market has to offer. That way, when conditions change, I am well prepared and can seize the opportunity to get exposure to potential big winners and new market leaders.
Click on Watch List chart to enlarge:
The watch list contains stocks that have put in bullish break-away gaps.Those stocks might set up at some later point in time. It also contains bullish cup with handle type of stocks and of course all time high stocks. Use it to replenish your own watch lists with the ideas you like best.
Too much thinking is dangerous. Stick to the process.
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