Updated: Apr 29
Thanks for taking the time to read today's blog post. In this series of posts we talk about trade and investment psychology and how to think different from the crowd. Please be sure to read the disclaimer on our site before moving forward, subscribe to our blog and follow us on social media (FaceBook, Instagram, or twitter)!
What is a unique benefit of technical analysis?
The fibonacci pattern offers us something very unique as a tool that other market participants may not be aware of; the ability to know when we should take profits in very strong bull markets. Think of Bitcoin's bull run in 2017. This is where resistance in the market may occur. We are taking profits, and we should be more hesitant about taking on more sizeable positions. On the opposite end of the spectrum, it can help us initiate positions and look for areas of support or even take profits on short positions.
Back in March of 2020 we got very bullish on the stock market, and indeed very much so on technology stocks as the sentiment was extremely bearish. After posting the following chart of the Nasdaq 100 Futures (Figure 1.1) and S&P 500 Futures (Figure 1.2) I posted the following statement, "If you don't think the $QQQ Nasdaq (technology index) can't hit all time highs, you're probably doing it wrong. $SPY $QQQ $XLK $NQ_F" Many retail traders, institutions and hedge funds were positioned for more downside at that time expecting the market to crash even further. What this creates in the markets is what we like to call "an event."
"Tops are process, bottoms are an event." This is one of my favorite Wall Street adages because it describes perfectly what happened in March/April of 2020. Like the GameStop saga, recently it seemed like we were making history every day in early 2020 with markets going limit up and limit down. The news cycle was selling fear like they love to every day they could. Sirens were whirring non-stop out my window due to COVID-19 running rampant, and if you were a misinformed investor, you were selling investments in your IRA in fear that the market might not recover. People do crazy things when their emotions take over, and when the pandemic, hit it was no different, and yes I've been there too!
The reason bottoms are an event is a culmination of three things occurring in the market: (1) new participants that get into the market sell on the fear the market might not recover and then have to get back in, (2) current market participants that are short have to cover when the market gaps up reversing to the upside, and (3) new longs are now initiating positions in the market seeing support has held and breaking in the direction of a new trend. These three combined events created an unusual up thrust in late March that caught many off guard unless you were prepared.
There's no need to panic!
The lovely thing about Technical Analysis is that it prepares us to make tough decisions during uncertain times without having to rely on fear as a mindset to make them. If you recall, there are several events that took place around this time that marked the bottom in the market: POTUS 45 finally concluded the harsh reality of COVID-19 and that it was a global pandemic, oil went to negative prices for the first time in our history, William Ackman went on CNBC and talked about how bearish he was and the difficult steps that our government would need to take to deal with the pandemic. If you look at the price of the S&P 500 during that interview, you will note that it coincides with the 38.2% fibonacci retracement from the chart above or $2,348.58, a typical first area of support when the instrument you look at puts in a top. We can see why Bill Ackman in the same interview was getting bullish on stocks and why we started buying too!
There's no reason to get euphoric either!
On the opposite end of the spectrum, we want to make sure we don't get too excited when our targets are getting hit as well. When we stay disciplined and execute based on our analysis, we are not allowing our emotions to control us in the market and get too euphoric. The idea is that bull markets top when everyone is trying to get in, and we are already positioned accordingly in the market so we don't need to worry about what everyone else is doing!
$SPX is now hitting the 3.618 fibonacci target of $4,067.55 based off the monthly chart. As we got very bullish last year in April, we now want to be taking profits in the market tiering out of long term positions in $SPY or stocks related to that index. Especially ones that are underperforming as they're sending the signals to market participants that while that indice is making a new high that can't even rally to new highs.
On a shorter term basis the 1.618 Fibonacci Target from the 2020 March lows is $4,153.62. If we continue to proceed higher short term this is a definitive area to take profits and adjust stops on current holdings. Areas where multiple Fibonacci targets are being met show strong signs of resistance in a market and would not be disregarded by any sensible investor or trader.
So does this we mean we immediately turn bearish and starting shorting everything insight!?
While there will be opportunities to short, especially with stocks underperforming in the market, we've broken out of a very bullish pattern - the megaphone pattern. Due to this we want to see what price does next. If after a move lower it may confirm our thesis of a short term top in the market or if we need some consolidation (where price moves between a defined period without increasing or decreasing in one direction) before moving forward.
The technicals that we use will also let us know if we continue to short or be aggressive in the market initiating new positions. Until then we stay disciplined as always.
Either way we'll let let price be our guide and let the market tell us what to do!
For now let's congratulate ourselves for holding long term positions and being disciplined!
Essex's Trading Quote of the Day (QotD)
“Tops are process, bottoms are an event."