Participating in Counter-Trend Rallies

Trading Bear Market Rallies

By Dr. Winton Felt

In bear markets, prices fall faster than they rise in bull markets.  Down moves are sharper and rallies tend to be quicker than they are in bull markets.  You can take bullish positions on those sharp counter-trend rallies, but do not expect to hold those positions long..

In a bear market, it is better to use very sensitive (very short-term) moving averages to generate your signals, assuming you prefer moving averages.  Moving averages tend to be slow in detecting a new trend.  Since counter-trends in bear markets do not last long, the moving averages you use must be short in order for you to have much participation in the rally.  For example, a 3-day moving average crossing above a 9-day moving average can be useful for generating buy signals for some stocks.  However we would recommend something more sensitive than a moving average to generate your sell signals.  A drop in price below the highest low since purchase or some other such approach would be much more sensitive to a change in direction.  However, this is also a situation where it is not necessary to wait for a change in direction.  The stock being near resistance can be a good enough reason to sell.  Fibonacci retracement levels, Parabolic SAR, Gann, and other studies can also be a great help in defining sell points before there is an actual change in price trend.

If a stock is in a downtrend, avoid talking yourself into the notion that the stock is about to turn, and that a counter-trend rally is the beginning of that turn.  Draw the overhead declining trendline of resistance that is defining the stock's decline.  Assume it will continue to limit upside trends until it actually fails to do so.  Even if the stock is about to turn, it is unlikely that it will follow a "V" pattern in doing so.  Usually a stock will "consolidate" or remain in a trading range for a time before rising.  If it does define a trading range, the high of that range probably will not be higher than the latest high permitted by the declining trendline.  In other words, in terms of the next trade, it makes no difference if the stock is beginning to move sideways in a trading range or if it is about to continue its downtrend.  Either way, you will want to sell when your stock is at or near the boundary marked by your declining trendline.

The rationale for selling before a moving average crossover takes place is based on the fact that rallies in a bear market are not only faster, but they are also of relatively short duration.  By the time the moving average crossover occurs, a good portion of the decline may have already taken place.  In some situations the moving averages will work fine as sell signal generators.  Try testing a few very short-term moving average crossover combinations for a stock in which you are interested.  Note the patterns of past crossovers, the delays of entry points in counter-trend rallies, and the delay in exits.  Does the pattern show that most of the time you would have been able to participate in a good portion of the rally?  If you cannot find a moving average combination that will enable you to participate in enough of the counter-trend rally to enable you to capture a reasonable gain for the amount of risk assumed, then using moving average crossover systems for the selling part of your strategy is not an appropriate approach to use on that stock.

In bear market rallies, our traders might sometimes use a "hit and run" approach. Here, you would make your purchase and sell as soon as you hit your target exit price or before that if there is any sign of weakness.  While you may end up selling before a move is completed, you can sell with a profit that is acceptable to you while removing uncertainty and reducing wait-time.  Always plan for the gains to be smaller, the price to change quickly, and the rally to be of short duration.

Links To Popular Articles/Lessons  Topics of Interest
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