My posts have been on the light side for the last couple of days as I’ve been preoccupied with a few things but more importantly, nothing much has changed in the markets from a technical perspective since my last few updates. We’ve had a few trades hit profit targets recently as well as a few exceeding their suggested stops, all of which I plan to update soon.
With the leading index, the $NDX, basically going nowhere in the last month (the $NDX is at the same level it was back on Sept. 6th), I’m sure that there are a lot of frustrated traders out there right now, both bulls and bears alike. As I believe a solid bearish case can be made from both a technical & fundamental perspective, one must realize that the economy, as well as the market, doesn’t turn on a dime. The economy is a lot like a supertanker when changing direction: slow and drawn-out. However, now image a supertanker in the process of making a turn with the helmsman steering to port (left) with Bernanke pulling the wheel as hard as he can towards starboard (right). Fight it as he may, ultimately market & economic forces or “currents” will prevail and the turn will be complete, although it’s just going to take a bit longer than usual. Just remember that major inflection points in the stock market, particularly those transitioning from a bull to a bear market, are a process, not an event. Maybe we are in the latter stages of that process right now as I believe, maybe not, as only time will tell.
My point is that trading during periods of market tops, or even relatively temporary inflection points, such as a slowdown within a larger economic expansion, can be very frustrating for both bulls and bears alike. Longer-term swing traders positioning short might become frustrated over a market that just doesn’t seem to want to drop, even if it’s not moving higher (and ditto for the bulls positioning long, while prices stay flat). Other than those lucky or astute enough to time their entries just before the next big breakout to the upside or downside, most traders are likely see many of their trades go underwater or stopped out as choppy, unpredictable price action is common during topping processes. Shorter-term traders, both bulls and bears alike, will more than likely become frustrated as well as the rate of failures for pattern breakouts (i.e.- “fakeouts”) usually increases during topping periods, creating additional churn and losses in their account and a breaking of their spirits.
What to do? Well, assuming that we are in the final stages of an economic expansion/early recession and hence, a market top, then a swing-trader wanting to capitalize on the short side might consider the following:
- Use smaller than normal position sizes
- Scale into positions over a predetermined time period or using multiple technical entries vs. taking a full position at once.
- Allow wider stops which should keep losses manageable due to your smaller position sizes.
- Have a plan(s) to cover all contingencies. Basically the market will do one of three things over the next few months: Breakout and move considerable higher; breakdown and move considerable lower; or trade sideways in a relatively narrow trading range.
If the market were to make a sharp or sustained move to the upside, shorts would need to have an exit strategy and while longs should have their wish-list and entry plan for new positions (as should the shorts that cover if they wish to reverse and go long). If the market breaks down, my opinion remains that the selling will likely accelerate faster than most expect, thereby causing many short-side traders to miss an objective entry if not prepared in advance. Preparing in advance means having a wish-list of stocks or etf’s ready to go with pre-defined entry and exit points. Those entry and targets can always be revised as market conditions change but trust me, when trading the short-side, a trader must be even more nimble then when trading the long-side. Stocks typically fall much faster than the climb, often wiping out months of previous gains in just days. Even more so, short trades tend to experience very sharp rebounds due to short-covering combined with long-side buying off key support levels. As many of the successful short trades posted on this site have shown, if you miss exiting at a target by a couple of days, hours or sometimes just minutes or even a few seconds, you will quickly give back a substantial amount, if not all of your gains.
Finally, if we chop around in a trading range, swing traders have a few options: If long, consider writing covered calls on positions to generate additional income; Adapt a more active “hit-n-run” trading style while focusing more on the intraday charts (something i will post more of if i believe that to be the case); Or maybe just step aside and wait for the technicals to confirm a breakout that has a good chance of following through, either to the upside or downside. I still believe that until/unless the longer-term overbought conditions and bearish divergences are removed from the charts, that any upside breakout from current levels will be limited. Bottom line: Be prepared (have a plan), be flexible (the market can & will do whatever it wants), and be patient (keep position sizes commensurate with your risk/loss tolerance and don’t let a sideways market wear you down).