"We wished to make this post on a day in which the markets started to rally, so as to give readers the latitude to exit their long positions gracefully should they choose to do so, and not leave them in a panic, which is not necessary nor productive." Jesse July 15
Bear market rallies, or 'relief rallies,' are sharp upward spikes in prices on the US equity markets.
They are fed by short covering. Those who are short, or have positions based on the assumption that the stock market is going lower, are forced to buy stocks either from fear of losses, or because they are undercapitalized and overleveraged. The leverage may be in terms of time (as in the case of stock options) or money (margin).
The bear market rally consists of a violent opening spike. That spike will be up to the nearest strong overhead resistance as the short sellers panic. Then the market will pull back, because there are no serious buyers yet to sustain the prices, and the early shorts have covered. Also, insiders will begin to feed their dog stocks into the public markets.
The prices will pull back to the nearest support. Once the bulls feel confident again, the buying will resume, this time more slowly as naive speculators begin to succumb to the 'good news.' The highwater mark of the opening price spike will be a definite target for this secondary move higher.
Often the initial effort to find support fails, and the bullish sentiment will pull back and try to find stronger support from which to resume the price advance.
Very infrequently there is a 'failure to rally' and a failure to find support at a near support level. Buyers (also known as 'the greater fool') are not to be found, and the dip buyers panic, and a freefall ensues. This also can be quite breath-taking, as the insiders are selling not buying, and the small speculators are exhausted and starting to panic. This is an uncommon event, but can be quite damaging if you are caught on the wrong side of it. This is how we came up with the term 'chasing nickels on the freeway' to describe it. Buying the dip in price in bull markets is easy money; buying the dip in bear markets is for gamblers.
The way we keep our orientation in these market events is to take a slightly longer time perspective. We like to watch the hourly futures chart, rather than the customary ten minute charts watched by daytraders. We also like to plot the support and resistance levels not only on the hourly charts, but also on the daily charts and keep a close eye on them. Why? Because this is how you know if you are still in a bear market or not. Are the longer term trends still in place?
The best way for most traders to play these markets is to stay out. The opportunity to be whipsawed is very high. Take a break. Go for a walk. The market will always be there. The greed of 'lost profits' pulls you back in, and then fear will take you out, on a stretcher if you are not careful.
Controlling one's emotions in volatile markets is the primary challenge for experienced traders.
Bear market rallies can be quite impressive. Wall Street insiders feed these rallies with stories and 'good news.' The financial reporters and many well-meaning people will go along with this because they wish to be optimistic, for any variety of reasons. Fundamentals can mean little in the short term in financial markets. Although in the longer term markets are 'efficient discounting mechanisms', in the short term a market is more like a tug-of-war, or a rugby scrum, dominated by the biggest players with the most money.
These are the trend corrections in which short term traders can make some very tidy profits, and insiders can unload more of their underperforming stocks on the unsuspecting public. The government and other officials are often complicit because they are seeking to calm the public and avoid a panic, so they will take whatever 'good news' they can get.
There is an ethical if not legal question involved. When does avoiding a panic become leading people into losses and bad decisions? If a major tsunami was approaching the eastern coast of the US, would the government be justified in hiding that fact, in telling people to stay in their homes near the coast, to 'avoid a panic?' We hope to see this tested in the courts in the next few years, in particular with regard to the financial news media and chief market strategists.
The way we are playing this market today, just as an example, is to add to some long positions in contra dollar plays on weakness (gold, Swiss franc and other instruments in bull markets), scalp profits from the primary trend of the equity markets, and to spend a little time with the kids, go for a walk, work outside, while we wait for this cycle of greed and fear to subside. (PS. We went into the close on the short side because we approached the end point of a classic short term rally. If we advance further tomorrow we will pull them back. - Jesse)
