The Four Stages of a Market Shakeout

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Buying dips in a bull market is a high reward – low-risk setup. The challenge is that it is not as easy as it seems when you look at past charts.

Here are the four typical stages of a bull market pullback (shakeout):

Stage 1: The indexes close at new all-time highs after a few up days in a row. Everyone is buying breakouts and chasing stocks. Making money seems easy. The fear of missing out defines people’s decision making.

Stage 2: Quick and unexpected pullback. Those who bought at the highs are now underwater. We are starting to see an increasing number of failed breakouts. The sentiment is sobering up but it is still mostly bullish. There are three distinct groups of active market participants here – Group A – those who are quickly taking loses; Group B – they are buying the slight dip; and Group C – those who wait for a more significant pullback to enter.

Stage 3: The dip gets deeper. The sentiment is starting to turn bearish. There is no trace of the fear of missing out. Volatility is rising. Headlines are predominantly negative.

Group A (those who quickly cut losses in Stage 2) are starting to think about shorting stocks.

Group B (those who bought the slight dip in Stage 2) are cutting losses, complaining about how choppy the market is and are going to a mostly cash position.

Group C (those who were waiting for a bigger pullback) are now scared and don’t want to buy the dip anymore.

Stage 4: Many stocks are down to levels of potential support or are starting to recover after false breakdowns.

Group A (those who started to short in stage 3) are now underwater and starting to cut losses. Overwhelmed by the recent choppiness in their account, they have lost confidence and are not thinking about buying stocks yet despite seeing some positive developments in price action.

Group B (those who went mostly in cash in stage 3) – the majority of them still don’t trust the market but some are dipping toes in the water with small positions and seeing positive results.

Group C (those who initially waiting for a bigger pullback but got scared when it came) are still suspicious of the market activity. Most don’t do anything. Some open small starter positions.

Stage 4 is typically the environment which offers the best trading opportunities from a risk-to-reward perspective. After stage 4, there’s Stage 1 again, where everyone feels that it is safe to go back in the market and making money is easy.

This four-stage cycle repeats multiple times in a general market uptrend and it is the reason why many active traders struggle in a bull market.

Check out my two best trading books:

Swing Trading with options – How to Trade Big Trends for Big Profits

Top 10 Trading Setups – How to find them, hot to trade them, hot to make money with them.

Momentum Monday – Dip Buyers Market

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Sell in May and go away or stay for new all-time highs? Last week finished with fireworks and multiple breakouts. This week starts with another trade war induced decline.

No trend can last without pullbacks which often come when complacency reigns supreme and the giddiness is at all-time highs. Dip buyers have been dominating the tape for most of 2019. This probably won’t change any time soon.

In this week’s Momentum Monday we cover the price action in AMZN, AAPL, FB, and TWTR, which are outperforming in a mixed tape. We highlighted the comeback in financials and the a few setups in software, semiconductors and biotech.

Check out my two best trading books:

Swing Trading with options – How to Trade Big Trends for Big Profits

Top 10 Trading Setups – How to find them, hot to trade them, hot to make money with them.

Three Stocks Setting Up for A Potential Breakout – NFLX, ISRG, DLTR

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December retail sales came at -1.2%, which is the worst drop in nine years. The market didn’t care much. Dip buyers stepped up and bought the dip in many technology, energy, and healthcare stocks. Positive reaction to bad news is a sign of confidence and optimism. Sentiment and momentum are what matter the most to traders because the market is a voting machine in the short-term.

Here are three stocks in a tight range contraction, which might lead to a breakout and another leg higher:

Check out my latest book: Swing Trading with Options – How to trade big trends for big returns.

Top One Percent Stocks – Feb 3rd

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I am continuing my weekly habit to post some interesting swing trade setups among the strongest stocks currently in the market. I look at the strongest 1-2% stocks. This means stocks having a relative strength rating of 99 or 98. I am interested in two major setups: a breakout, which I can buy intraday or an anticipation setup, which I can potentially buy the next day if it clears new 3-day high.

Here are a few anticipation setups for next week: GKOS, RARX, INSP, VCEL, and FN. As you can see, biotech stocks are dominating.

Check out my latest book: Swing Trading with Options – How to trade big trends for big returns.

Momentum Monday – The New Trading Range

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When SPY broke below its 260-280 box two weeks ago, it entered into a downward spiral and quickly dropped to the low 230s. Few were prepared for a 10% fall in seven trading days. The oversold bounce came a bit later than expected by most but it was a powerful one. Those who bought the extreme weakness too early, are very motivated to sell when their break-even levels are reached. This is why bear markets characterize with monster rallies followed by powerful reversals.

What’s next?

SPY has most likely entered into another box and we will see range-bound trading in the next few weeks. That range could be 240 to 260, or 230 to 250. The smartest way to approach the new box is to play the ranges and stay away from breakouts and breakdowns because most of them are likely to fail on longer time frames.

In the last Momentum Monday for 2018, we covered enterprise software stocks like OKTA, TEAM, and WDAY; the coming competition between DIS and NFLX; the price action in SPY, AAPL, and others.

Happy New Year!
Check out my latest book: Swing Trading with Options – How to trade big trends for big profits.