Date: 5/17/2022
Author: Chris Hood
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We’ve had a couple of green days in the market.
And I know this very instant that many retail traders are about to make a disastrous decision in their accounts.
Loading up on SPY long calls and waiting to cash in on the reversal.
I’m here to put a bit of healthy fear into you and hopefully save you some heartache and lots of cash.
I’d like all the bulls to consider how stocks move in an uptrending market. First, up for a while, then a bit of a pullback to a key level of support.
And occasionally big flush of selling.
All traders want to sell and take profits from their winning trades. They want money just like you.
When enough smaller players cash in, it might pull the price back to the 8- or 13-day EMA. However, when traders with significant holdings and various hedge funds take money off the table, expect the price to pull back to the 21- or 34-day EMA.
These pullbacks are healthy and normal. They allow you to add to your position if you’re playing a long trend.
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In the trend-based time frames that I use, holding for a few weeks or less, I consider the uptrend intact when:
- Visually, the stock price is moving from bottom left to top right on the chart
- The stock is above the weekly 21-period EMA
- The stock price is above the daily 21- or 34-EMA
Which EMA is most important to me on the daily chart depends on how long I intend to hold and the “personality” of the stock.
If we translate this to a downtrend, then the converse is true.
Any stock below the weekly 21-EMA and the daily 21-EMA is trending down. So even if it rallies, I’m highly suspicious if it cannot break the daily 21 and hold.
So as far as I’m concerned, SPY is not yet viable as a long position (unless day trading) until it can get above 410.00 and stay there.
I’ll be comfortable putting on a long options trade at that point.
Remember that the trend is your friend. Just as your odds of winning are dismal when trading short on the pullbacks of a bull run, you can easily get smashed by going long under the daily 21 EMA.
Although these EMA levels are not the only indicators I use, I avoid going long on a down-trending ticker.
I’ve learned never to buck the trend.
So here’s what I’m looking for to separate an actual market reversal from these normal pop-ups in a bear trend.
I’m waiting for SPY to get two daily closes above the 21-EMA before I can be bullish. One close above that level, followed by another below, is a potential opportunity to short.
The two closes above mean that the daily 21 has become a significant level of support. At the same time, the touch and drop pattern suggests it’s still acting as resistance.
Sure, this is conservative.
If the trend changes, I may miss out on the very earliest part of the move, but I’d rather be slightly late and wait on confirmation.
It’s just a lesson I’ve learned over the years by having been caught in these “bull traps” or “head fake rallies.” Go long too early and get destroyed on the drop.
Is this the reversal we’re hoping for?
I have no idea, nor does anyone else. But these are some of my critical rules for staying on the right side of the trend.
And they’ve proven consistently profitable to me over the years.
Heed my advice or not, according to your own plan.
Honestly, I don’t care if someone else manages to get in on an actual trend reversal a bit earlier than me. I’d much rather be safe than sorry.
Adding lots of long exposure to a potential reversal can wipe you out if it fails.
Even with confirmation, always scale into the trade with a small starter position.
What I’m really saying is be CAREFUL and PATIENT.
The market never stays down forever. So make sure you keep your capital safe for when the trend actually shifts.
Cheers,
Chris Hood
PS – My system recently netted our AlphaHunters subscribers a solid 75% gain on OXY in just nine days, even in this market. I’d love to have you on board and help you make the most of your trading. Click this link to learn more.
