The bounce during a correction is one of the most sought after trade. I personally do not know why this is such a sought after trade however it likely has something to do with being ‘smart’, or believing you are ‘getting a deal’ when buying at a lower price. Whatever the reason, I choose NOT to trade this set up. My decision is a direct result of how comfortable emotionally I am with buying into the hole, I feel much more comfortable buying a breakout with momentum than I do ‘in the hole’, but then again this is just me. There are pros and cons for each and every strategy but the key is to be have a process and be consistent in implementing it.
With this being said, the next couple of days, including today – everyone seems to be trying to buy this dip. Perhaps a little too many people? It seemed as if everyone was trying to buy this dip today but this is simply a thesis and by no means is a tradeable pattern.
My thesis for the next few days to couple weeks is a bounce back and then bear flag, followed by another push lower. For this to happen the $SPY bounce will need to contained to 181.50 and then roll back over.
I tweeted today that there is more to a correction bottom than a candlestick as many people were in a rush to call today’s candle a ‘hammer’ candle, which is commonly known as the REVERSAL candle after a correction. My point was that there is much more to a correction bottom than one single candlestick. Of course, in 2013 this was not the case whatsoever and every correction was literally ended with the hammer bottom only to sprint back to new highs without even a breath. The markets, over the long run, usually do not work like this. The most healthy and common type of market correction bottom follow this path:
1. Steep pullback or correction
2. Bonce back into resistance
3. Another flush lower
4. Sometimes a hammer bottom, but not always
5. FOLLOW THROUGH (KEY)
6. Price Commitment to FOLLOW THROUGH (also known as a bull flag)
7. A new move to new highs or a another run higher.
There it is, about seven steps to a market pull back or correction. Many people seem to forget the FOLLOW THROUGH and commitment part of these steps and simply assume a hammer candlestick will mark a bottom.
We all have biases and theses towards the market at any given point and this is OK. However, it is vital for the long term successes of ‘us’ traders to recognize a change in market character and be ready to react accordingly to it with a process that was known BEFORE HAND.