If you have been trying to trade the market over the past few weeks, you probably feel as if you are on a bungee cord that never stops bouncing up and down. These market conditions tend to wreak havoc on your confidence and capital base UNLESS you understand who is in control of price so that you are able to anticipate what price will do next.
Today we are going to study the Downside Bounce.
When the market is moving down many sell short traders get caught in huge whipsaw bounces that wipe out profits rapidly and make many traders wary of selling short.
It is not enough just to look for a sell short candlestick pattern, or to look for a downside crossover on a popular indicator, what you must also do to have consistent success in your trading is to understand at all times: Who is in Control of Price.
Many traders were ready to sell short on Thursday of this week due to the panic selling on Wednesday and the doom and gloom outlook for the Japan nuclear crisis. Retail traders flocked to sell short and then got whacked big time by a sudden big move up. What happened? Why didn’t the market continue to move down?
It was easy for me to see that the market was poised for a substantial bounce because the evidence was in the charts of who was in control of price and where price was most likely to stop. So even though news was very negative, the risk of a bounce was real.
When stocks are moving down there is a shift of control periodically. Who is controlling price should always be foremost in your thoughts as this tells you how long the run is likely to last and which support levels will cave and which will hold up.
As a stock moves down due to panic selling this action is swift, steep, and often on inconsistent volume patterns. This is because the panic sell off is controlled by small lot investors and small lot retail traders who are selling at market out of fear of losing money.
Below we see early rotation out of this stock by large institutions. They are moving out while the stock is in a sideways pattern and before it really moves down. Smaller funds and small investors are buying this stock on dips. But the selling of large lots dominates during the sideways pattern.
The Institutional investors are fundamentalists by nature although a few also incorporate technical patterns nowadays as well. So they are moving out due to news they know about that no one else has heard yet. NEWS is NOT created equal. News siphons out to different market participant groups at different times so be aware of this fact. Usually by the time retail traders hear about news, it is OLD NEWS and can cause whipsaw conditions.
If you were in this stock holding it for a position trade, intermediate term trade, or long term investment, these are patterns that give you very early warnings that the stock is due to correction more deeply. This gives you ample time to exit your held position prior to the meltdown.
Chart 1
Chart 2
Chart 3
As the downside begins to accelerate with more energy, the control of price shifts to the sell shorters both professional large lot sell shorters and retail sell shorters. These traders are pure technical traders and rely upon technical patterns not fundamental patterns. Retail traders tend to also be news oriented especially if they day trade so that is a factor as well. Retail accounts for about 10% of the overall market action.
Pro traders are very good technical traders. The best use a charting program such as MetaStock and have developed their own proprietary system they don’t share and keep their secrets to themselves. That way it doesn’t become public domain where it can be exploited and manipulated by hundreds of thousands of retail traders all trading the same system.
If you are a retail trader using a system that is highly popular then you are at risk of a Quant writing an algorithm for a big player to track the popular system and trade against it. Ever have a trade that started out great only to move slight down before moving up again? This is NOT market makers; it is QUANT algorithms being used against you. Market makers do not bother with small lot trader activity.
Welcome to the world of automated trading.
Since we know that pro traders are in control of price AND that Quants are using their algorithms to sniff out blocks of small lot orders all trading the same system, it becomes relatively easy to determine how support levels will behave as a stock moves down.
Next week: support levels and how they interact with who is in control of price.
TechniTrader® will be sponsoring a special Webinar just for MetaStock traders in early April. Be sure and check our website at technitrader.com for more information. We are going to be discussing Option Trading using the powerful MetaStock Charting Software program.
As always:
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
(c)2011 Decisions Unlimited, Inc.
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