The Trend

How to Spot a Correction (and What to Do about It)

Two of the biggest catalysts in any market are fear and greed.

We’re told to buy excessive fear and sell excessive greed. 

Quite often, though, traders will sell on fear and buy on greed. But that can be a costly error, one that even Warren Buffett can attest to. To this day, he still advises that a “climate of fear is your friend when investing; a euphoric world is your enemy.” And of course, we all remember his advice to “be fearful when others are greedy and greedy when others are fearful.”

In fact, too much greed can be a sign of a market top.

Mysterious Pattern Keeps Appearing With Big Stocks

A few days before Amazon’s dramatic surge a mysterious pattern appeared. It was just spotted
again with two BIG stocks. Their names are (Continue)

Look at biotech in June 2017. Around June 20, the iShares NASDAQ Biotech ETF (IBB) exploded from a low of $290 to $320.74 in days. 

At the time, according to Bloomberg:

An executive order the Trump administration is preparing will contain industry-friendly policies instead of more aggressive proposals. The policies being considered include efforts to promote cooperative arrangements between drugmakers and insurers, speeding approval of new treatments, and finding ways to make other countries pay more for drugs.  “It just sounds more and more likely that the focus is going to be on removing barriers to entry rather than a direct attack on pricing,” said Brian Skorney, an analyst at Robert W. Baird & Co. “That’s a pretty industry-friendly scenario if it does end up occurring."

Traders bought that new en masse, even though a great deal of it has been priced in. The news was out. The catalyst fueled the run. Greed – excessive greed – emerged.  After a move like that, it’s time to take the wins and move on, or wait for the pullback.

A sure sign of a potential pullback can be seen with technical pivot points, too. Relative strength (RSI) was the highest it had been since August 2016.  Williams’ %R was greatly overbought above its 20 line. Money Flow was already beginning to reverse as well.

Any one buying at the time was buying simply because every one else was.  But that can be costly, per the maxim of Warren Buffett.

So what’s the best way to trade such a situation?

There are three ways. One, if you were long prior to the catalyst, a trailing stop loss can be used to protect gains and remove emotion from the trade. Two, you could sell the trade and wait for near-term pullbacks to buy again. Or three, traders could always take a position in a short biotech ETF or even buy a put option on the IBB to capitalize on near-term downside potential.

In short, always be aware of where the herd is getting far too greedy. Doing so could work in your favor. 

When it comes to large moves in stock prices, a mysterious "X-Pattern" often appears on the charts before stocks make a significant break to the upside or downside. Click Here to learn more about this chart pattern.