Miscellaneous thoughts including market talk, strategies, and a defense of dip buyers who didn’t get their heads bashed in

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  • on October 2nd, 2011

 

We’re short-term traders and probably a good 50-60% of the people we follow in our stream also share the same time-frame.      It’s our nature to always want to yearn for resolution of ranges even though our rational side tells us that we could be in this trading environment for a good while longer.   Take a look at the following chart of the $SPY– we left on the 50SMA (the black line) and simply drew arrows with every big move up and down.    The range was basically established between two trading sessions: Friday, August 05 (rumors of US downgrade) and Monday, August 08 (first trading day of confirmed US debt downgrade).

We have not trended the last 2 months, we’ve been completely range-bound.  On Friday even with the incredibly bearish close we still are above where we were on August 08.

If someone presented us with this chart we would say:   Wow, ugly chart.  Steep, descending 50SMA that hasn’t even been tested once since the sell-off began.   Usually what happens in these situations is that the stock remains in range until the descending 50SMA starts to catch up and then price is pushed down, thus transforming from a  range-bound price-action to a down-trending one.

Just as buying the dip worked well for a long time (ceased to work as well once we broke 2009 trend-line) the motto is short every rip until it stops working.    Shorting break-downs in broken charts also work (witness $NFLX through 125 support this week) but it’s not our preferred strategy (shorting resistance is our prime strategy for this type of market).  One day it will stop working — but likely not until we break the range and/or 50SMA.

When the market was above the 2009 trend-line and traders were buying dips (successfully) many would say “one day buying the dip won’t work and they’ll get their heads bashed in”.  We never understood that thinking.  The idea of buying dips is to do it on shorter-time frame within a larger trend.    That is,  buy pull-backs if longer time-frame trend is intact.   We were known as consummate support buyers and over last two years made many live calls buying support.  However, on August 02 in “Time to Re-assess” we wrote that:

“We have written for months that we would buy the dip until we broke the 2009 trend-line.   Well, today we broke the 2009 trend-line.”

In our outline of “How to catch a falling knife” written in May we wrote about the three errors traders often make in “catching falling knives”.   Error number two we wrote in this post was:

” Buying a broken stock instead of  buying oversold into support on longer-term bull trend.     We would never get into a broken stock just because it’s “cheap”.  In our business nothing gets cheaper faster than an already cheap stock.    When we say we’re buying on “support”,  it automatically means that the long-term bull trend is intact.    If it’s a broken chart, by definition, there is no support.”

Once the March 2009 trend-line broke then the game for buying support was essentially over.   The 2009 trend-line for us was “the big kahuna” and we wrote a dozen posts before the break referring to it as the big level that would change everything.  Traders like ourselves, and many that we respect on the stream, did not get their heads bashed in — they realized the trend was broken and they shifted strategies.

Of course we speak about ourselves and about other professional traders like us — it’s likely many retail investors who did buy the dip for the last two years and kept on doing it in the last two months in fact did get hurt.    However, the accusations about dip buyers were often made against traders making support calls on the stream, not the average Joe buying dips from his E-trade account.

Now we’re on the other side and in a bear trend meaning that the modus operandi is to short resistance until it’s proven otherwise (break of range/break of 50SMA).      In our experience this has been the best combination we have found — trend-trade, and employ counter-trend strategies (reversion to mean), but always in the direction of the longer time-frame trend.     Not always easy to execute, but that’s the foundation of how we trade.

 

 

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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