Last week was the biggest weekly decline in the market for over two years.
Sentiment seems to have shifted extremely quickly, perhaps understandably given the speed of the move, and how long it’s been anticipated after such a lengthy advance. This is classic ‘stairs up, elevator down’ price action. Whether the bears press and make their advantage tell is still as yet unknown. As always price will let you know.
This is where having a process, and more importantly having the discipline to execute it, is paramount. I often say that your stop should always be where you can accept or know you are wrong. One of the reasons for this was demonstrated in last week’s price action.
Before you enter a position you need to have determined where your rationale is invalidated so you can then size your position. You do it calmly and rationally. But when that stop looms days or sometimes weeks and months later, the circumstances under which you have to take it will likely be very different. Like last week.
I don’t typically analyze the market short-term that much, but late last week I was amused to see a signal from a long-forgotten system I devised many years ago to catch short-term oversold conditions. This was when I was experimenting with system dynamics, ie the trade-off between systems that have high win rates but the average loss is way bigger than the average win (and eventually one of those losses wipes them out), or the exact opposite, low strike rate, big avg win vs avg loss, which is what I do now.
This system “Steamroller” is absurdly simple (but you know I love that). When the 5-period RSI goes below 25 it buys the next bar open, it exits on a profit of 0.75% or a loss of 3.0%. That’s it. Its win rate is usually around 90% like all good newsletter vendors without AUM, except that it’s rare to get a signal. When you overlay it on the $SPY it currently has a 21 win streak and flashed a buy signal late last week (it’s almost out with another win too).
Make of it what you will. Again, I do not trade this stuff, but I think it just underlines the significance of last week’s move. We need to acknowledge it and remain disciplined taking the exits as they are presented to us. Those same exit signals triggered by rules you devised to protect your capital and tell you to exit when you might be inclined to do otherwise. Remember?
Even if the Steamroller bags another win, so far this looks like a pretty weak bounce.
I’m wading into subjectivity here but I view Thursday’s decline as such that the longer it takes to recover the lost ground the less likely it becomes. That is, the technical condition can deteriorate further without any further decline in price. This is how markets correct through time as well as price. We can easily have an attempt at a bounce but as time goes on the MA’s cross over and previous support becomes a resistance level where bears become emboldened and press shorts.
Basically, we’re in no-man’s land where battle lines are drawn and actionable triggers in either direction are determined. For trend followers this is what we do constantly, but for those without such a systematic approach lines in the sand get drawn above or below which major decisions are made.
Even though this environment alerts us to manage risk and honor stops, don’t also rule out the possibility that new opportunities emerge within it. We saw this earlier in the year when there were still names making new highs as other areas of the market took pause. So far, this decline looks broader in nature but interestingly there are some traditional momentum names shaping up well, hardly the action you’d expect in a lasting correction.
Over a week ago before the decline got underway I had additional long signals in $AAPL, $DPS, $HPQ, $LMT, $NOC, $QIHU, and $IPG. I also had an entry in $ARRS which has already been exited after taking a post-earnings hit. It happens. Not very often, but it happens.
Stay disciplined, manage risk, and have a plan for whatever may transpire.