We have discussed in our market analysis updates since mid July about being bullish of US Stocks. The markets were charging higher but on Aug 5th we mentioned needing to be able to adapt to “what the markets are telling us because things can turn on a dime”, quoted from August 5th’s analysis titled “Is it Time to Buy Stocks?”. The Dow Jones has since dropped 778 points from the highs earlier in the month to the lows on Aug 21st. In this week’s analysis we’re going to discuss determining your risk in a trade BEFORE an entry. Professional traders always minimize losses and manage their risk following rules which allows living to fight another day. Professional’s do not “hope & pray” the market goes in a direction and they are not too proud to take their lumps and move on to the next trade. On to our chart!
On August 5th’s analysis we discussed that the Stock Market is in a potential Bull Trap, an area that is sucking in a lot of buyers and eventually the sellers potentially can outnumber the buyers leading to a market correction. Many market participants are not aware of these trap areas and bought the market top. These “last to the party” buyers now have had to painfully experience a 778 Dow point drop, ouch! So at what point should they take their losses and realize they entered the market at a bad spot? Now after a 778 point loss, 2000 points lower, 3000? The chart below shows weekly bars/candles of all the stock index exchange traded funds and shows a pattern called a Three Inside Down pattern on three of the four Indexes. This is considered Bearish/weak Price Action that Institutional money is well aware of and could lead to more selling. The selling could last for a week, could lead to a 50% market crash, and of course the markets could also break above these patterns negating them proving the market wants to go higher. Whenever a trader or investor enters a position we must realize how important determining the risk in a trade is before our entry, otherwise a small loss can grow to a large loss! The chart on the very bottom is the same chart of the Dow Jones scrunched up to show data dating back to the year 2000 displaying the extent of the rally and how much room below there is for a potential correction. Does the chart’s recent Bearish price pattern mean that markets are going to fall off a cliff immediately? Not necessarily, these bars/candles represent a week per bar so it’s possible and normal for the market to chop sideways and even rally for a couple weeks to the recent August highs. Last weeks bounce on every index except the Dow is a perfect example of this bounce. For any late to the party buyers out there, now is the time to determine your risk!