The Index fell more than 1.6% yesterday, closing at a two-week low amid a fresh turn in the swaying stimulus talks. Stocks, which opened slightly higher in the hope that a stimulus deal would be reached ahead of the Nov. 3 election, dramatically reversed the course of the increasingly elusive deal.
Now, the trick is to find out if yesterday's drop – the worst since September 23 – was so powerfully bearish that the entire stock was spent, lowering the price, or just a corrective profit move before the price increases again .
We pause here and clarify that we have no answer to that question as we do not have a crystal ball. However, we can and will discuss the forces at work, their consequences, and how to navigate the various possible outcomes.
As always, let's look at the map first.
As we can clearly see, the benchmark fell below its upward trend on September 4 since its March low and September 24, although it was not clear at the time that the price had hit its low. As far as all traders knew, it could have been part of a lower movement just like the September 11th low. However, after completing a small one-month V&G bottom, a pattern has manifested that registers a trend reversal from the direction of highs and lows.
The two rising peaks and troughs recorded since the bottom of Sept. 24. Being registered led to an upward trend in the short term. That means that – in the short term – advances are considered part of the trend, while declines are believed to be earnings adjustments that invite dip buyers to add another leg to the rally.
Ergo, yesterday's sell-off is believed to be a set-up for another rally, as long as the short term lasts. A fundamental driver could be a breakthrough in talks about fiscal support, the progress of a possible COVID-19 vaccine or a presidential tweet.
It doesn't really matter which event boosts stocks. The point is that according to the principles of technical analysis, stocks are ready for another rally. Traders are just looking for an excuse. Case in point: Notice how the sale stopped dead at the point of the H&S neckline, where the highlights of the reversal pattern meet.
Trading Strategies
Conservative traders would wait for a new high above the September peak to allow the short term trend to return above its uptrend line (or a new uptrend line) as equities record a new peak, extending the upward trend over the medium term.
Moderate traders would risk a long position when attaching support above the neckline with at least one long, green candle.
Aggressive traders probably view an entry at this level as a reasonable risk, at least from a risk and reward point of view, since the price is on top of the support. However, there is a risk of buying on a sale, and good money management is the difference between trading successfully and failing – regardless of the analysis. Here's an example:
Trade Sample
Import: 3,425
Stop loss: 3,400
Risk: 25 points
Target: 3,550 – Oct. 12 high
Reward: 125 points
Risk / Reward Ratio: 1: 5
Author's Note: This is just a trading example, a term that suggests there are other approaches to trading this asset. There is no one right way to trade it. There are several strategies that could work as long as you stay consistent, giving you the opportunity to recoup losses and room for profit. Your personal circumstances affect trading. Consider your timing, budget and temperament.
