July 16th, 2009

Forewarned is Forearmed: "Traders’ Remorse" and the "Inflation Trade"

“Traders’ Remorse” is a term I’ve used several times recently but don’t think I ever fully explained or demonstrated it before. Given what I see evolving among stocks of the old “inflation trade” and what I believe the S&P 500 Index will do soon after it crosses above the neckline of the inverted head+shoulder that goes back to October, 2008, it seems apropos to do so now. Moreover, some believe that the conclusion of the “traders’ remorse” correction is actually the best time to initiate a purchase.

Quoting an excellent description from MetaQuotes Software:

“After a support/resistance level has been broken through, it is common for traders to ask themselves to what extent new prices represent the facts. For example, after a breakout above/(below) a resistance/(support) level, buyers/(sellers) may question the validity of the new price and may decide to sell/(buy). This creates a phenomenon that is referred to as “traders’ remorse”: prices return to a resistance/(support) level following a price break through.

Price action following this remorseful period is crucial:

  • either the consensus of expectations will be that the new price is not warranted, in which case prices will move back to their previous level, classic “bull or bear traps” (or false breakouts) where or
  • investors expectations may change causing the new price to be accepted, in which case prices will continue to move in the direction of the break through.

A good way to quantify expectations following a breakout is with the volume associated with the price breakout.

  • If prices break through the support/resistance level with a large increase in volume and the traders’ remorse period is on relatively low volume, it implies that the new expectations will rule (a minority of investors are remorseful) or
  • Conversely, if the breakout is on moderate volume and the “remorseful” period is on increased volume, it implies that very few investor expectations have changed and a return to the original expectations (i.e., original prices) is warranted.”

Remember when everyone was talking about the emerging world economies generating new demand on all commodities pushing those stocks up dramatically? What happened then was that everyone started second guessing the assumptions and prices started to falter.

Individual stocks will act differently producing a wide range of chart patterns-but each is a valid example of “traders’ remorse”. Stocks may form an “inverted saucer”, a horizontal channel, a symmetrical triangle, a descending flag. Name it, you’ll see it; but they all mean the same thing:

  • AKS (AK Steel)
  • MTL (Mechel Steel)
  • ANR(Alpha Natural Resources)
  • STP (Suntech)
  • PAL (N.A. Palladium)
  • ATI (Allegheny Tech)
  • BUCY (Bucyrus)

I look at hundreds of charts daily and could find many more (most of these are from the Spreadsheet list of ). If you’re in a stock that experiences traders’ remorse, don’t panic; if you’re not in one of these stocks, remember it’s the best time to get in.

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  • Anonymous

    How about UYM ?

  • Guru

    The case could be made. Similar genre, if you like.

  • Anonymous

    How do the buying volumns mean what "they used to", when we now have the highest percent of trading being done by Goldman Sachs et al, using computers competing with other computers?

    I'm not disputing what you're saying. I'm trying to understand; but I believe something has changed fundamentally about the market.

  • Anonymous

    Hi Guru,

    Just curious to know if charts are
    pointing to bull market or atleast
    more rally from here , how is 12%
    unemployment fit in the picture.

    Where are the consumers getting
    money from to spend after real estate
    collapse and loosing their jobs.

    Most of the US companies INTC, IBM
    etc mentioned the profits are coming from overseas.
    So basically stock market is not
    a proxy for economy.


  • Anonymous

    I'm a bit confused and would like some more insight.

    All of the charts that are posted show increased volume on the upside but even higher volume during the remorse period. Does that imply that the stock prices are generally trending below the breakout level?

    Thanks for your insight!

  • Guru

    My view of the charts is that the breakout itself is associated with high volume but volume tapers off as buyers begin to back off and the stock moves into the remorse and retreats back to the trendline.

    We'll know whether support holds at the trendline when both volume and prices begin to move up again.

    The same holds true for the Index. We're not going to break above the inverted H+S neckline without a burst of volume. The market will experience a remorse period if demand volume (the burst) peters out.