June 28, 2006 at 8:44 am | | Comments 1

Why Upside Has Been Limited

Lately we’ve seen occasional bounces with flashes of brilliance (like the June 15th rally which was the best one-day point gain for both the NAZ and S&P 500 since March 2003), but the upside has been significantly limited. Since the major indexes started trending lower back in May, the upside we’ve seen has merely been the flash-in-the-pan type. Why is that so often the case during bear markets?

Consider the speed of the 2 recent market declines. They were both downdrafts where the selling was heavy and constant with no real breather on the way down. Both selloffs came with streaks of 8 consecutive down sessions for the NAZ (5/9 thru 5/18, and 6/2 thru 6/13). Combine these ugly selloffs with the fact that so many participants in the market can’t seem to take a loss no matter when they occur (they aren’t disciplined traders who know when to sell stocks!), and you get the ingredients for persistent pain.

Let’s look at the dynamic of how this happens. Stocks fall through mental stop loss areas and those who are long are now facing heavy losses. Then the vacuum of selling continues, making bad trades worse. Losing positions become very ugly, and they do it quickly. Things finally settle down for a few days and the market gets a relief rally. Once the bulls see higher prices, they have the chance to exit at better levels, so they sell into the bounce to raise cash and exit their bad positions. This selling pressure limits the upside momentum, as strength is met with supply rather than additional demand.

The market started this downtrend in May and remains there today as I write. Cash is a good place to be if you aren’t short. Thursday has the potential to provide an explosive move with the Fed announcement, but trying to get in front of it is a coin toss. Wait for proof that the downtrend has ended before getting long, always employ stop loss orders, and you won’t see your hard-earned trading capital sucked out of your account the way so many did in recent weeks!

Jeff White
President, The Stock Bandit, Inc.

[tags]Trading Psychology, Stock Market, Stock Trading[/tags]

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  1. From » One-Question Interview at StockTickr: Lessons I’ve Learned in the Downtrend on Jul 26, 2006

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