It’s always a balancing act determining exposure to stocks when markets turn. Plunge in too quickly with your swing trades and you risk outsized losses on failed rally attempts. Act tentatively and you don’t fully participate in the rallies that work. It’s been top of mind in this latest recovery attempt.
The Nasdaq composite started the year with an 8.7% rise at its peak in January (1). What was most unusual about the strength is that it followed what was already a stellar 2017. In SwingTrader, profit taking on the way up naturally led to lower exposure for the downturn. Most setups looked extended at the top. As a result, removed stocks didn’t have new names replacing them.
When the Nasdaq dropped 3.8% on Feb. 5 (2), we already had been out of the market for two trading days. While it was a great position to be in, it’s only one side of the equation. The next challenge is when do you get back in? Especially since a dramatic drop can lead to quick powerful moves on the bounce.
However, we also had recent history of how these vertical violations of the 50-day moving average tend to recover. Nasdaq charts worthy of study include May 2010, August 2011, August 2015 and January 2016. These all had similar slices through their 50-day moving averages. Their recovery to new high ground took months not days, with some short rallies that quickly failed or led to choppy action. Contrast that with October 2014’s 10% correction in the Nasdaq. The difference there was the initial drop was more gradual and less vertical.
Using precedents in analysis is helpful but when it comes down to it, you must not get so wrapped up in the precedent that you ignore what the current market is actually doing.
A reversal attempt in the market on Feb. 6 (3) looked promising so we attempted a test trade with Lululemon (LULU) the next day. We exited a day later as the market undercut the reversal day. You’ll notice in the precedents noted above, a failure on the first one or two rally attempts is common.
So far, this market’s second reversal attempt (4) is holding and we booked profits on two stocks, Abiomed (ABMD) and Nvidia, (NVDA) and have solid gains on a third stock, Fibria Celulose (FBR). More exposure occurred due to things working in our favor but we didn’t get overly aggressive. The high failure rate of initial rallies is still at the forefront of our minds. That caution served us well as this past week saw indexes hitting resistance multiple times starting on Feb. 16 (5). The Nasdaq bumped its head up against 7300 and turned tail four consecutive days while the S&P 500 and Russell 2000 saw their rise slowed at the 50-day moving average lines.
Where do we go from here? Continued sideways action won’t encourage new buys but may be a good thing in the end. It fosters more setups in stocks. We finally saw a solid close in the S&P 500 and Nasdaq on Friday, a promising show of strength. If accompanied by sound patterns in individual stocks, more swing trades will follow.
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