A good trader should be able to adjust to changing markets. 2 to 20-day swing trades work beautifully in steadily rising markets. We experienced those for the most part from February to August 2016. Intraday trades are the real money makers during corrective markets. Volatility spikes during corrections and when volatility spike, three things usually happen:
1) Stocks trade in much wider daily ranges than usual. The intra-day moves are humongous and there’s plenty of liquidity behind them. Upside and downside moves that used to take 5-10 days are taking 2-3 hours during corrective markets.
2) There are many reversals. Many breakouts and breakdowns fail. Stocks gap up one day and then gap down the next. Such environment makes 2-20-day swing trades more challenging. Even if you trade in the direction of the general market’s trend (which is obviously down during corrections), you will have to go through numerous high-magnitude squeezes until you get paid properly. The only way not to get shaken out from normal price reactions is to use a very wide stop and a smaller position size.
3) Correlations between stocks and different asset classes rise as well. This means that stocks bounce and dive together regardless of individual company’s merits.
Speaking of rising correlations, what makes a strong impression in the current market pullback is how many stocks are holding extremely well and don’t pay attention to what the indexes are doing:
Small-cap biotechs, many of which don’t have any earnings or revenue, continue to break out and gain ground. In a typical market correction, those are among the hardest hit stocks.
Chinese ADRs, which are super volatile in general, continue to show relative strength. Again, this is usually among the most pressured group during corrections. Not this time.
Quite a few high-beta, momentum stocks are holding well, as well. A quick look at my SL50 momentum list shows numerous breakouts this week – GIMO, ANET, LOGM, FNSR, ZLTQ, etc. Those types of stocks tend to underperform during corrections.
All of the above makes me consider the current correction just a 5-8% garden variety pullback within a bull market. Maybe, it is too early to judge and fear will accelerate when prices go lower. No one really knows. Just thinking out loud and sharing a few observations.
