It seems as though virtually everyone is bearish on the markets these days. The ‘news and noise’ certainly reinforces that visceral emotion—but the news and noise is almost never right about anything. All one has to do is to look at key market turn dates throughout history and then match up the headline news stories of the day to see just how unreliable that sort of anecdotal reasoning is and always has been.
After a more than 70% run up off the March lows, many, if not most, remain in a state of apparent disbelief about the current rally and the popular consensus seems to be that a significant pullback is well overdue.
I want to address that in this post and offer a potential entry/exit strategy for the bearish Type A’s amongst us to consider.
First, let’s take a look at how NOT to establish a bearish position in a rising market…
Establishing short positions by scaling into a rising and fully trending bull market is a very risky strategy. That tactic has been disastrous for bears who have continually tried it since the market turned up from the March lows—and shorting against the trend after a new range breakout has likely ruined more than just a few trading accounts.
Shorting a breakout ABOVE the breakout level is one of the worst rookie trading errors that can be made (and holds equally true for going long below bearish breakdowns). The old adage that ‘the trend is your fried’ has stood the test of time for a reason. Trends can extend much further and much longer than anyone anticipates. Fighting the trend can put a trader on the wrong side of momentum with no clear exit strategy other than the personal ‘uncle’ factor, where the pain of losing eventually causes capitulation.
So, let’s look at a very aggressive bearish strategy that still respects the VST trend and provides a hard stop to exit if wrong—with likely very limited losses.
Bullish breakouts occur when a pivot high of significance has been exceeded and held. Since most countertrend speculators tend to be short to very-short-term traders, I’ll concentrate on that timeframe for the following example…
The most recent VST pivot high of significance for ES was 1114.50 on 12/4/09. The market spent 12 trading days below that number until the current breakout on a close on 12/23/09.
That number of 1114.50 is significant because it defines the bottom of a new trading range. So long as price is above that line, the new trading range remains valid. The very first sign that something is potentially amiss in the bullish world will be a failure of that range support.
So, consider focusing on that 1114.50 number as a sort of ‘line in the sand’ where you determine that no short trades will be established until/unless a break of that line occurs—then that line would then serve as a backstop for protective stop placement. Think of 1114.50 as a no-nonsense dividing line where a VST short trade is simply wrong if held above.
Stop running often occurs at the end of a trending move, and most people tend to place their stops above a significant pivot (bears) or below (bulls). If this current move is an ending move, then after the stops have been run, there should be a fast move down under the old pivot high, and though there may be an eventual retest of the level, once a bearish move gets started—it likely won’t be touched again if a downdraft ensues and could therefore serve as an excellent countertrend entry point.
I am not a countertrend trader, so though I would not initiate a short trade against the trend, I would certainly take note of a move back below the range breakout line and start preparing to peel off profits from existing long trades. I would also expect to see new Top Spotter signals across the indexes when a tradable top is in place.
For now, the market is trending in all timeframes and a fledging breakout is underway.
Stops and Targets was designed as an institutional money management tool, and so it tends to emphasize closing bar basis and to reflect a more patient approach to investing than many day traders are used to. However, the intratrend support and resistance numbers are very useful trading targets for ST and VST traders and the gain to risk numbers are extremely helpful in determining the relative merit of initiating a trade–both trending and countertrend.
This market has been very frustrating for many day traders since the recent tight range coupled with no near term upside resistance has given the illusion of no opportunity (especially when the individual’s preexisting bias has been to the short side). That really hasn’t been the case, though, as range trading strategies (such as the VST trend channels illustrated earlier) have been very effective during the consolidation.
We are very near the top rail of one of those key VST channels today (approximately ES 1127-1128 area). It is worth watching that number to see if there is a selling reaction which leads to something more bearish as higher trends would begin to roll over, if so. If, on the other hand, that VST trend channel is broken decisively to the upside—then bears who have been shorting the consolidation zone and held above the breakout could be in trouble.
So, the bottom line for VST traders is to watch ES 1114.50 (the equivalent line for short-term traders from Stops and Targets is 1104.50). That is the line that represents the trend breakout level and that bears would need to take out and hold to get something going on a pullback. Above that line is a bullish breakout and no one has any idea just how high or how long a new move can go.