When Trends Emerge... Embrace Them!The price of any asset is always the correct price because it is the level where buyers and sellers meet in a transparent environment, the marketplace. A price trend is the most accurate reflection of the market’s sentiment. When buyers are more aggressive, prices rise, and when sellers overwhelm buyers, prices decline.
The stock market trend reversed
The S&P 500 is the leading stock market index
The trend bent
Ride the wave until the technical position changes
Never try to pick a top or bottom; the market’s sentiment will tell you all you need to know
In his 2004 book, The Wisdom of Crowds, author James Surowiecki used case studies to prove that “the many are smarter than the few, and how collective wisdom shapes business, economies, societies, and nations.” A price trend embodies Surowiecki’s work, and that is why the trend is always a trader or investor’s best friend.
When I first began my trading career in the early 1980s, my mentors taught me never to “fight the tape.” They were old-school traders who learned their craft in the days when stock prices were printed on a ticker tape. Fighting the tape is going against the trend.
When the path of least resistance of a market changes from bullish to bearish or vice versa, it is a signal to take profits, losses, and reverse a risk position. The most successful trend-following traders and investors ride trends until they bend, aiming to take the most significant percentage of profits from a bullish or bearish price pattern.
There can be plenty of false signals that lead to choppy results but catching a significant trend and riding it like a surfer rides a wave can be gratifying and highly profitable. The recent price action in the US stock market points to a significant trend change from bullish to bearish.
The stock market trend reversed
After reaching a record high of 4,808.25 on January 4, the March E-Mini S&P 500 futures contract ran out of upside steam, reversed, and has made lower highs and lower lows.
The chart highlights the decline to the most recent low of 4,212.75 on January 24, a 12.4% decline in only twenty days. The futures contract was around the 4,420 level at the end of last week, closer to the recent low than the early January high.
The Fed’s more hawkish approach to monetary policy has weighed on the stock market as stocks compete with bonds for capital. Moreover, the geopolitical landscape has likely caused selling as tensions between the US and Russia have risen to a post-Cold War high.
The S&P 500 is the leading stock market index
The S&P 500 is the most diversified stock market indicator and the bellwether for monitoring the overall equities asset class.
While the recent selloff may appear as another speed bump, a close below the 4,495.12 level on January 31 would put in a bearish key reversal trading pattern on the monthly S&P 500 chart.
A bearish reversal in Bitcoin and Ethereum on November 10 led to a price implosion in the cryptocurrency arena that took prices over 50% lower at the most recent lows last week. The S&P 500 closed more than 60 points below the critical level on January 28.
The trend bent
Trends reflect market sentiment. As we move into 2022’s second month, the stock market looks more than shaky. Higher interest rates, geopolitical problems, COVID-19 variants, rising inflation, supply chain bottlenecks, the potential for rising US corporate and individual tax rates, and other issues have caused selling to emerge in the equities market.
There have been plenty of false signals in the stock market over the years. However, when corrections occur, they can be brutal. The last substantial correction took the S&P 500 from 3,393.52 in February 2020 to a low of 2,191.86 in March 2020 as the worldwide pandemic gripped markets. The 35.4% drop from one month to the next was a reminder that when the trend bends, it is best to follow the sentiment. The cost of trend-following is choppy results when markets display false breakdowns or recoveries. When trends emerge, the profits can more than compensate for short-term losses. The bullish trend in the US stock market bent in early 2022 and is now bearish at the end of January.
Ride the wave until the technical position changes
Trend-following is like surfing. It can take a long time to paddle around through small waves until a substantial one appears on the scene. Surfers look to ride the wave when it arrives.
The S&P 500 has already dropped by over 12% in January, and a bearish reversal at the end of January could cause even more follow-through selling. Daily price volatility has increased, and rallies during a bearish trend can be particularly nasty for those holding short risk positions; thus, the term “rip your face off rally.” The critical factor in trend following is to begin riding the wave early so that you can stomach the ups and downs that naturally occur as the market gyrates between higher and lower prices on an intra-day and even intra-week basis.
Those gyrations can cause the emotional impulses that cause many traders and investors to lose money or minimize profits. For trend-followers with the fortitude to suppress emotions, riding the bullish or bearish wave until it changes direction is the formula that separates winners from losers over time.
Never try to pick a top or bottom; the market’s sentiment will tell you all you need to know
Our emotions want us to be correct, and the emotional impulses are more concerned with calling a direction than profiting from the market. It is virtually impossible to call bottoms or tops in markets consistently, and successful trend-followers tend to be long at the top and short at the bottom. While this may seem counter-intuitive, it is the critical factor for profitability.
Sentiment is a powerful force that often ignores news, expert fundamental analysis, and all other noise that surrounds markets each day. Sentiment creates price trends that indicate the path of least resistance of prices. Picking tops or bottoms denies physics that teaches a body in motion tends to stay in motion. In finance, the trend is your friend until it bends is the same construct.
As of the end of last week, the trend in the stock market was bearish, and we will ride the wave until the market sentiment tells us it is time to ride another in the opposite direction. We are constantly long or short the highly liquid markets we trade, and we may get chopped up when sentiment is confused and provides false signals. However, we are always positioned to participate when the big moves come.
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Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.
