August 9th, 2009

Traders’ Remorse Correction: Wait it Out or Ride it Out?

A loyal reader just wrote: “i was wondering how one would go about handling trader’s remorse. i got into this rally late. do you think it’s best to sit on the sidelines for the next month or so and let things correct, or take the chance and stay in.”

Great question and one that I’ve been pondering myself ever since writing on June 13 in “Summers, 2003 and 2009: Market Similarities and Differences“. In that piece, I went back to the recovery out of the 2003 Tech Bubble Crash bottom and found that the market back then went into a traders’ remorse consolidation also. I wrote:

“After straight up 26% over 4 months, the market lost steam and started to consolidate, a pause that lasted two months through the summer to the end of August. During that time, also, volume started to dry up (the red line in the volume bars) but OBV continued to move ahead indicating that demand continually exceeded selling. Over the summer, not only did the moving averages continue to improve but at the beginning of August, the 200-day crossed above the 300-day creating a perfect “Bull Cross” where the Index and its 4 moving averages were perfectly bullishly aligned.”

Another month and a half have passed and the similarities are still uncanny. The market continued to advance and is 9.4% higher since that post and 49.36% from the March 9 bottom. Here’s the 2003 bottom chart from that June 13 post. Note that top and bottom of the Traders’ Remorse channel (June and August, 2003) touch trendlines that, six years out to 2009 happend to be the neckline of the inverted head-and-shoulders and Friday’s close. The 2003 chart:

The chart as of yesterday:

While I don’t give much credence to Elliot Wave and Fibonacci Retracement theories (that same as their not thinking much of trendlines and moving averages) but I should point out that many are pointing to the fact that the Index today’s close represents an exact 38% retracement (of the distance between peak and trough), a key Fibonacci benchmark. Many, therefore, see this as a logical place for a pause.

Having said that, I looked back to see how individual stocks performed during this period in 2003 and found no typical reaction among individual stocks. As a matter of fact, the thing that best describes a “Traders’ Remorse” correction is that it all stocks don’t follow the Market. If those stocks that buck the trend and continue moving up lose their momentum, the Traders’ Remorse correction becomes a full, multi-month consolidation or, worse case, evolves into a top and full reversal.

Those stocks that had previously been in an uptrend may temper the slope or retreated slightly; those that hadn’t yet started moving up continued stayed flat or decline further. Those that had been above key moving averages may have tested those averages; those above trendlines tested trendlines. While the market declined 10% from the consolidation pattern top to bottom, there was no consistent mirror image in individual stocks. The phenomena was too short and not too steep.

I can’t advise you as to what you should do. It depends on:

  • the stocks you are thinking of buying and how strongly they’ve performed.
  • how closely you monitor the market, how you react to volatility.
  • how diversified your portfolio might be between stocks and other assets like ETFs and ADRs of foreign stocks and currencies, commodities and fixed income.

And then again, we could all be surprised, as we have been all along this year, by the market’s resilience. It could stall for a couple of weeks and then resume its upward momentum. So if you are having trouble sitting on the sidelines and are itching to get into the action, one Industry Group that have perfect bottom reversal patterns and seems to be anticipating the next round of stimulus spending are companies involved in infrastructure, like:

  • JEC
  • CX
  • FWLT
  • JOYG
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  • Piazzi

    I am an elliottician,

    and I pay a lot of credence to trend lines and moving averages, and I know quite a few other Elliotticians who do as well.

    So, I must say, that what you say about us by ways of characterization is wrong

    regards,

    piazzi

    markettime.blogspot.com

  • Guru

    My apologies, Piazzi. I meant no slight it's just I don't understand how or why fans and lines and arcs at fixed percentages work from a supply and demand perspective. I'd appreciate your insight.

  • Piazzi

    guru,

    nothing is really fixed, they are, at best, guide lines based on history and statistics

    EW is mainly about price action, many get too involved with Fibs and projections because they are easy to do.

    I think the most important indicator of all is price, and what better way of reading it than in smoothed form of MAs,

    It is the price (and human action) that defines the waves and not the other way around (that is point lost to some newbie Elliotticians), an MA is a crystalization of price action

    just my two pennies, and I am an avid fan of your methods

    BTW, I was just trying to say that soem Elliotticians care about MAs a great deal

    keep up the good work, and keep keeping us out of trouble

  • Z

    Joseph, I've been thinking a pull back has been overdue, what you call traders remorse, *but* I think I am like many others who are either adding longs or covering shorts.. If we do not pull back soon I would think it's unhealthy for a continued advance.

    On Friday I spoke with an analyst I used to work with at a conservative investment company here in Toronto and they are hoping for a pull back to be able to buy and not chase stocks. I sold most of my longs back in May and I know many others that are in the same boat and sitting on cash.

    On the bear side of things I know from a lot of the bearish blogs I read that people shorted the SPX around 1000.. maybe they are right, I suspect for the short term they will be but I don't see where the selling/panic is going to come from. The market has already been washed out. With a few crash calls this weekend I doubt bears are going to have their way.
    Z

  • Guru

    I wrote on Twitter that I see the market straddling the 300-day MA for the next 6-10 weeks, much the same as it did before crossing decisively above the 200-day MA. That would take us to 950 in mid-September.

    I agree, that money is losing patience waiting for the pullback the never seems to materialize but I don't understand the logic saying that "If we do not pull back soon I would think it's unhealthy for a continued advance."

    The implication is that, contrary to past experience, lateral or continued upside movement will consume potential momentum rather than, as is usually the case, upward movement ignites momentum.

    Under current circumstances and unless there's new evidence or events, I'll vote for momentum spark argument.

  • Z

    I always thought the process of pulling back in a rally shook out weak hands and got buy and hold investors more involved. When a stock or market runs straight up isn't full of momentum guys that will pull out in an instant?
    Z
    ———————————-
    "I agree, that money is losing patience waiting for the pullback the never seems to materialize but I don't understand the logic saying that "If we do not pull back soon I would think it's unhealthy for a continued advance.""