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Is The Market Panic Over Or Is There Another Leg Down?

In our monthly newsletter I discussed how simple trendlines can be used for broad market analysis. In a nutshell, the focus should be on when an up- or down-trendline is broken. These are typically the best times to take action instead of waiting for a new trend to become established with much of the gain already priced in.

  • Tip: Focus on the trend breaks and not simply following the trend for the best and earliest entries

S&P 500 With Weekly Bars

 

 

 

 

 

 

 

 

 

 

 

This was probably the most helpful tip for me when trading either one minute bars intra-day or monthly bars for broad macro-timing. But there were a couple other trading patterns I regularly noticed when trading – moves that seemed to suck in a lot of investors.

When a trend was broken, prices didn’t usually drop straight down like a rock. Well, sometimes it did but most of the time it went down in legs with mini-rallies that failed. And you can’t blame investors and traders for wanting to get in these mini-rallies since buying at a bottom is where the majority of profit is made. How could you tell whether you should jump aboard the rally or not? Moving averages can provide some help.

Moving Averages

Another incredibly simple technique is to use moving averages. When intra-day trading I used 10 and 20 period moving averages which have application in longer-range charts as well. What I noticed daytrading was that a rapid drop (think of falling off a cliff) often had a sharp pullback to the 10 period moving average before the next leg down. So that you can visualize this, look at a basic example of Apple and how shares pulled back to the 10 period moving average before the next drop. Generally speaking as a trader, I would short the stock if it hit the 10 period moving average and started to drop again.

Apple With 5 Minute Bars and 10 Period Moving Average

 

 

 

 

 

 

 

 

 

 

 

That was the failed first mini-rally. The second rally was usually a lot stronger and could make its way up to the 20 day moving average. But if the first drop was shallow, the price may test the 20 period moving average right away. In either a shallow drop or the second mini-rally of a steep drop is where I would be extra careful. If prices were very strong it could sometimes blow right past the 20 period moving average, make a small pullback, followed by a new upwards trend. You don’t want to be short when prices reverse.

So how does this all relate to what the market is doing right now?

Recall that the upwards trend just broke a couple weeks ago. The drop wasn’t too deep and we are now seeing the first test in the form of a mini-rally. Will prices jump upwards with only a small correction? Is this a set-up that is sucking in new investors wanting to get in at a seeming bargain?

 

 

 

 

 

 

 

 

 

 

 

 

It is too early to tell either way but we are reaching decision time. Daily prices are hitting the 20 day moving average. This also happens to be a resistance point in addition to a recent market high of 1434. If prices fail to clear this hurdle over the next few days, we will likely see a test to the downside with 1400 support being tested. While the odds are stacked slightly in favor of another downturn based on the current chart, we will watch the market like a hawk to see how it reacts. Although the previous uptrend is broken, we haven’t really seen evidence of a full-blown down-trend… so we position ourselves and wait.

It Is All About Positioning

How are you positioned? We still recommend holding at least 25% cash and investing in stalwart strategies such as Dividend Value, Dogs of the Dividend Aristocrats, Defensive Utilities and the various ETF strategies. For now we feel that all but the most speculative trader should pass on the Smallcaps Fiscal Momentum since it can react with high volatility in a down market. The key to sound investing is not as much about forecasting as it is about positioning yourself appropriately according to the current climate. Just make sure you are not chasing old trends such as buying utility stocks after a 50% market drop or buying small caps after a lengthy bull market.

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