Different setups and tactics work in different markets. As traders and investors, our job is to adapt to any significant change in the market environment. Bull markets last long enough to condition people to buy every dip. Then when the inevitable correction comes, many get hurt and lose a lot of what they made during the uptrend. Corrections last long enough to condition traders to take quick profits because if we don’t, they tend to disappear quickly. When the new uptrend begins, we have to condition ourselves to stay with our winners longer.
No one knows how long this correction will continue. Typically, there are clear positive momentum divergences near market bottoms. In the meantime, it pays to remain nimble.
In a little over a week, the major U.S. stock indexes erased months of upside. This is nothing new. Markets tend to fall a lot faster than they rise because fear can quickly turn into panic while bull markets tend to climb a wall of worry which keeps greed levels at check.
The typical market correction has three main stages: First, we see a swift and widespread move lower which reaches the momentum low of a correction. Then, there’s a snapback rally which typically retraces about half of the decline. Third, there’s choppy price action and potentially another leg lower which tests the momentum low from the first stage and even surpasses it. At some point in Stage 3, we will start noticing positive momentum divergences which typically mark the end of the correction.
10-20% corrections are a normal part of the market cycle. We get them once every two years or so. Corrections bring incredible opportunities for those who manage to preserve their capital and confidence during them. The deeper the correction the bigger the opportunities.
The momentum divergences we have been talking for the past few weeks were followed by more and more companies warning that the coronavirus will impact negatively their sales this quarter. It seems the market finally decided to listen. The Nasdaq 100 lost 2% on Friday and had two back to back distribution days. Semiconductors and enterprise software leaders were among the hardest hit. The recent uptick in volatility will probably be a wake-up call for many who have been chasing mindlessly momentum stocks in energy, space, AI or it might just be considered as another buying opportunity.
There are certainly enough stocks that are still holding well and even trying to break out. If this is the beginning of a deeper 5-10% pullback, those stocks will likely just build new bases, so there’s no rush buy them now.