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| While the market rips back to highs, Red Dog is stuck at jury duty |
Technical traders use retracement rules to measure the strength and validity of a potent move. This week we have gotten a powerful example of why knowing how to use retracement rules is invaluable for the active trader.
After poking 1300 on the S&P last week, the market took a nose-dive Friday. A potent down day like that sometimes leads to a further move in the same direction. The way you measure the validity of a potent down move is by watching the action in the days immediately after. In order for that move (in this case, Friday’s) to have control, the market shouldn’t retrace more than half of the down bar. Usually for extreme potency you don’t want to see it give back more than a third.
So for the complexion to remain extremely bearish, the S&P (using a thirty handle move off the highs back to 1275) shouldn’t have bounced above 1282-1285. However, the market did just that Monday. Plus, there were some stocks still having break out type action. The market was definitely not sounding a very bearish tone.
Then today, the S&Ps opened near 1288-1292, which was more than half of Fridays down move, completing negating its validity according to our retracement rules. While I have been cautious with longs (partly because I am stuck here on jury duty), no part of my brain has been comtemplating shorts given the action.
If you were at your desk active trading, the question is: how did you handle it? Did you lighten up and not get back in at all? Did you lighten up and short a little on Monday’s gap open and stay short? Did you go short Monday and add today, disregarding basic retracement rules? Then, did you get pressed above the 1300 level again and blow up your account or take a huge loss?
Personally, when we see potent down days like that, my first inclination is to get flat, be cautious, and ask questions later. Just because you don’t get the perfect price after a down move like Friday doesn’t mean you can’t get back in and make cash flow. It is my philosophy that in the long run, you will always make more money if you take caution rather than trying to be first to the party.
*DISCLOSURE: No positions
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