What to Do After a Bearish Market Signal

May 18, 2015 by  
Filed under News, Trend Trading

 

A few weeks ago we did something we rarely do for our subscribers.  We featured a short trading setup on DDD.

 

Shorting is tricky.  Many say more tricky than making a bet that a stock will go higher.  So we only do it when the market generates a bearish signal that tells us that some some kind of correction is likely in the near-term.

 

Now some avoid shorting altogether because they think its somehow “wrong”.

 

I personally believe its wrong to enter a “naked short” where the shares are not even sourced when the shares are sold.  In order to enter a massive short that can drive down the price.

 

But I do believe that providing some economic incentive for investors to take a bearish stance and explain why is a good thing.  Otherwise, who is going to make the case that a stock is a bad investment?  And do extensive research to support a bearish view so investors and traders can hear both the bullish and bearish case?

 

But if you disagree with shorting, you can always buy put options and make a lot more money than shorting if you are right.

 

Anyway, the point of this article is to discuss what you should do once the market turns bearish.  Whether you trade both long and short.  Or just stick to long trading opportunities.

 

First of all, there are many bearish market signs that traders look for.  And some look at price action only.

 

We use what is called a “bearish market signal” or confirmation signal to determine when the market is likely to enter a new correction of some magnitude.  Popularized by the founder of Investors Business Daily, we have used this signal to go bearish in our newsletters right before the “flash crash” and all of the steep sell-offs in 2007 through early 2009.

 

One mistake traders make is to automatically sell everything and ignore the market for a while after a bearish signal.  And not to watch the market closely after the bearish signal.

 

Sometimes after a bearish signal the market will only see a modest correction and then resume its trend higher.  Especially during the early to middle phases of a long-term bull market.

 

What we do after a bearish signal is sell our weakest performers, maybe hold onto our best position, and make sure to follow our sell rules very closely.  And hold off on entering any new long positions.

 

And look for the best shorting and put option candidates.

 

And then we take a wait and see approach.  And update our list of top growth stocks and stocks beating estimates by a wide margin with rising future estimates.

 

We then hold our breath as the market attempts its first rebound after the bearish signal.

 

If the market rebounds strongly and convincingly with good volume, we become more aggressive.  We also go long again if the market takes out the 52-week highs.

 

If it takes out the highs on weak volume, we apply our buy rules more strictly and only take on the very best trading setups.

 

And if the market continues to sell off and confirm the bearish signal, we find more short setups and wait until the next bullish market signal to go long again.

 

Our book that comes free with most subscriptions explains everything in more detail. 

 

But the main point is that you have to be on your toes after the bearish signal.  And not just turn your back on the market and assume the bearish signal will be confirmed. 

 

Its sometimes just a small correction followed by another strong move to new highs within a couple weeks or so.

 

In our Daily Alert we are constantly on the lookout for stocks that are holding up well in good technical formations during a market correction.  And then we feature them after we see a bullish confirmation signal (or the market has a smaller pullback followed quickly by a move to new 52-week highs) as they reach an ideal technical entry point.  An effective trend trading strategy.

 

These stocks are often among the big winners in the next market uptrend.  Keeping these things in mind is important to successfully navigate your way through the dark, murky waters after a bearish market signal.

 

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