In these inflection point situations, our objective is not to find data to support the bullish case, nor to find data to support the bearish case, but rather to prudently develop a plan to increase our odds of being properly positioned for the next sustained move (up or down).
BEGIN WITH THE FACTS IN HAND
After Monday’s sharp selloff in stocks, the S&P 500 was still up 1.97% YTD, which means the longer-term setups on annual charts have not been negated. From a simplified perspective, the last major event in the S&P 500 was a new all-time high. As of this writing, the market has made a higher low above the February low. While the look of the chart below may change, it has not changed yet.
TRYING TO FORM A BOTTOM SCENARIO
It is not unusual for the market to be extremely volatile and frustrating while trying to form a lasting bottom. Think about the November 12, 2018 session in the context of the volatility and frustration near the 2011 low.
Notice in the chart above, even in the context of big swings up and down, the market for the most part is making very little progress either up or down. We can draw horizontal lines and hit price spanning several months, which is a form of consolidation. The 2018 chart below shows sideways action over the past month. In these situations, overtrading can lead to whipsaws and frustration.
A recent Short Takes post noted:
“It is not uncommon for the stock market to push higher and then backtrack to retest the prior low, something that may or may not happen in 2018. “
If a retest of the October 29, 2018 low of 2,603 is in the cards, it is prudent to keep in mind that short-term violations of a prior low can be followed by sharp reversals. For example, the first low in 2011 was made in August at 1,101 (see chart below). The August low was violated by a small margin on a closing basis in early October. The following day the market dropped well below the August low intraday, but reversed sharply before the close, finished green, and well above the August low. After everyone’s stop-loss orders execute, markets can rally sharply.
Notice in the chart above how many whipsaws occurred between the August 2011 low and the October intraday low of 1,074. The “what happened next” chart below puts the correction and period of wild volatility into a longer-term perspective.
ALTERNATING BETWEEN IMPROVEMENT AND DETERIORATION
Last week, the S&P 500 gained 58 points and we could have shown numerous examples of improvement in the data and on the charts. Monday, the S&P 500 dropped 55 points and we could show numerous examples of deterioration in the data and on charts. Flips between improvement and deterioration are not uncommon during periods of volatility and consolidation (see charts below).
GUIDEPOSTS CAN REDUCE WHIPSAWS
While there is nothing magical about any particular level of possible support or possible resistance, having reference points can help reduce overtrading until the market tips its hand one way or another in a more convincing and decisive manner.
OPEN-MINDED AND DATA DEPENDENT
Given the S&P 500 closed Monday 123 points above the October 29 low and 194 points above the February 9 low, we still have logical guideposts to manage against. The excerpts below from the October 30 Short Takes post still apply:
No one knows how 2018 is going to play out. A fact-based case can be made for both the big-move-up and big-move-down theories. Typically (not always), if we can step back from the day-to-day swings in price and our emotions, we will have time to prudently get allocated in line with the evidence, regardless if the outcome is wildly bearish, as it was in 2007, or wildly bullish, as it was in 2016.
The vast majority of common investing and trading missteps are related to having a very short-term focus and making changes based on short-term fear. The market will eventually tip its hand in the “new downtrend” or “correction followed by a new uptrend” direction. If we can shift our focus to the bigger picture, the odds of success will increase significantly. If we remain focused on daily fluctuations and short-term outcomes, the odds of success will decrease significantly.