Trade Prep: Sell the Rips
World markets continue to punish investors to begin the new trading week.
Chinese stocks are dragging us deeper into the red this morning. The Shanghai Composite dropped 1.5% to post its lowest close since 2014, Bloomberg reports, punctuating three weeks of losses that have erased $3 trillion from the market.
Stateside, futures remain in the red as traders digest the market’s latest rout. The S&P 500 fell more than 4% last week, led by tech and momentum stocks. While Friday’s rebound into the close prevented a total meltdown heading into the weekend, it did little to repair damage caused by the relentless selling we’ve experienced over the past two weeks.
Looking ahead, another tumultuous week for stocks could seriously rattle investor confidence heading into earnings season. With that in mind, we need to prepare for a more difficult trading environment.
First, the market will probably bounce from oversold levels this week. But the big question is what happens after stocks catch a bid.
The S&P 500 has finished lower by more than 4% on the week 15 times since March 2009, LPL Research’s Ryan Detrick notes. It’s finished higher by an average of 2.6% the following week 12 times.
While these stats are encouraging, we shouldn’t expect a miraculous turnaround that rips stocks back to new all-time highs. As stocks correct, traders will flip from a “buy the dip” to “sell the rip” mentality, opting to unload losing positions when the market rallies.
Powerful rallies are common during corrections. Trouble is, they don’t stick. If we’re going to test the waters with a trade on the long side, we’ll need to keep it on a short leash. Tight stops and shorter timeframes are two crucial points to remember if we take any signals this week.
When swimming in volatile, corrective markets, breakouts are guilty until proven innocent. The stock market had been very forgiving for the better part of the past six months. Momentum leaders provided outsized returns with few (if any) deep corrections as the major averages quietly trended higher.
In an accommodating environment, we’re able to give our trades the benefit of the doubt if they don’t perform right away. That’s not the case anymore.
Bad news gains traction as markets correct.
It’s easy to ignore negative headlines when stocks are posting new all-time highs ever week. But when the major averages turn lower, negative headlines start to “matter” again. Price leads the news!
It was easy to dismiss trade war fears when the market was rising. Now, financial pundits are citing these same concerns as potential drags on performance for the fourth quarter and beyond.
Wild price predictions will also receive plenty of attention as investors remain on edge. For example, the threat of sanctions against Saudi Arabia following the disappearance of journalist Jamal Khashoggi prompted this splashy story over at MarketWatch:
Unfortunately, headlines like these won’t help us navigate a volatile market and produce consistently profitable trades. Tune out the news and stick to the charts. If we properly prepare during the correction, we’ll be ready to strike once new trades set up.
Use this opportunity to build a new buy list.
We’ll continue to watch how the former momentum leaders perform this week. Our goal is to spot which stocks and sectors that have the potential to become new market leaders. Building a list of strong trade candidates will keep us one step ahead of the herd — and ready to book gains once the dust settles.