On Monday, my post had the tongue-in-cheek title, “How I made the perfect trade in the S&P“.
That was a cheeky thing to say so early in the trade, but I had strong reasons to believe the trade would go well. Remember, I was proposing a short trade in a very long bull market.
Shorting into a rising market is normally regarded as trading suicide. In the Trading 101 course, the first lesson is: the trend is your friend.
But trends eventually change, and when they do, your profits can rack up mighty quickly if you get in early; that’s what makes a good trader. The earlier you can take a short position in a trend change, the bigger your profits. There is no value in getting into a new trend too late as it readies for a reversal.
Getting in early gives you another valuable advantage: the trade risk is at its lowest near the top. That may sound counter-intuitive, but as the market declines off the top, you run the greater risk of running into some large rallies which can easily stop you out of a promising position too soon.
Of course, my style of trading is slightly more aggressive than normal, and I understand some traders need to see more work on the downside before making a short commitment. Each to their own.
Naturally, no-one can be 100% certain that a particular trade will produce a profit. All we can do is examine the data and trade on probabilities. If the market follows your predictions, you’ll gain confidence in them; that will allow you freedom to set price targets you can adjust in light of further price movements.
Let’s look at my S&P trade to see how it works out in practice.
All the signs suggested a fall – lo and behold…
I had pretty solid evidence to suggest where the S&P was going; one of the clues was the five-wave motive pattern on the 15-minute chart, in the downward direction off the high:
After that wave 5 low was in, I could say with some confidence that the trend had likely changed. Now, I needed to find a low-risk entry, which I did (see Monday’s post).
On Monday, my Elliott wave roadmap was clear – I had a series of 1-2s down. The market was then hard down in what I call a ‘third of a third’ wave.
This is one of the strongest patterns, and usually indicates that the market will head hard down, taking no prisoners.
Sure enough, markets have tanked since Monday. This is the situation this morning:
With my trade in good profit, I will be looking for a suitable point to take partial profits according to my split-bet strategy.
Complacency is bad for bulls, but good for shrewd traders
With the S&P down 70 points off last Wednesday’s 2,120 high, you will be reading comments such as this:
“It’s OK, everyone was expecting this correction – it’s a healthy sign!”
“Hey – this is just another dip to buy, so get buying!”
“The economy is fine – GDP is going up, unemployment is going down, so what’s the problem?”
“Stay calm, stocks are not expensive and the bull market is just getting going!”
“If the market falls a little further, the Fed will come to put out the fire again as they have since 2008.”
These sentiments are typical of the advice dished out by the media when – horror of horrors – stocks actually decline a little.
They are uttered by bulls who have married their positions and are in no mood to get a divorce.
Attitudes like that start bear markets: before too long, though, manic levels of complacency (low Vix readings) and bullish sentiment around the top give way to a gradual realisation that panic should have started earlier.