There is Strength in Market Weakness
Stockscores Foundation for the week ending December 10, 2018
In this week's issue:
In This Week’s Issue:
- Stockscores’ Market Minutes Video – Is This Stock Market Correction Part 2?
- Stockscores Trader Training – There is Strength in Market Weakness
- Stock Features of the Week – Weekly Breakouts
Stockscores Market Minutes – Is this Stock Market Correction Part 2?
Markets are showing signs that there may be more weakness ahead. This week, I tell you what to watch for, discuss the importance of maintaining your focus when trading, give you a couple of stocks to consider for next week and look at a recent day trade in the trade of the week on AMD.
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Commentary of the Week – There is Strength in Market Weakness
Simple approaches to any practice usually work the best. Finding the simple solution is not always easy, doing so can take the most experience. This is true in trading too and one simple concept to keep in mind when trading stocks is that there is strength in weakness (and weakness in strength).
What do you do when you are optimistic about a stock? Assuming you invest in stocks at all, you probably buy. When you are pessimistic, there is a good chance you sell.
Suppose there are 100 people who can trade the stock market and approach the market in this rational way.
If 30 of them are optimistic about the market and 70 are pessimistic then there are 30 potential buyers and 70 likely sellers. The sellers are stronger and will likely push the market lower.
What happens when a pessimist sells or an optimist buys? The seller no longer has shares to sell and becomes a person who is more likely to buy in the future. The buyer now has shares and is a more likely seller in the future.
If most people in the market are optimistic, they are also likely owners of the market and less likely to buy in the future. The more optimistic the market, the more likely people will sell in the future.
If most people in the market are pessimistic, they have likely already sold and are therefore likely to be future buyers as prices fall.
Market strength is driven by optimism that is likely to turn to pessimism once prices get high enough. Market weakness is driven by pessimism that will eventually turn to optimism once prices get low enough.
That is why weakness brings strength, and strength brings weakness.
Keep this in mind when analyzing a stock. It is why I don't like to chase stocks that have been going up for a while. I prefer to buy just when stocks start to go up. I also like to sell just when upward trends are broken rather than sell after a stock has been going down for a while.
You can apply this thinking with a very simple chart analysis method. Use trendlines to define who is in control of the market and then look for a change of control. A downward trend means the sellers are in control so watch for a break of the downward trend to indicate the buyers are going to come in off of the sidelines and turn the market around.
There is strength in weakness as long as you get the timing right.
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This week, I ran the Stockscores Simple Weekly Market Scan in search of good long-term charts worth considering for longer term trades. Here are two from the Canadian market.
T.ABX is showing strength like many Gold stocks, breaking up from a rising bottom after a recent break of the downward trend line. The chart is showing a bottom fishing pattern, good for a longer term hold candidate.
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US Small Cap stocks have suffered lately and broken their upward trend line (on the IWM ETF). RWM is an inverse ETF on that group that will go up if this sector of the market continues to go down. It is a leveraged ETF which means it will suffer time value decay as it has to be re balanced daily to maintain the leverage. This means good risk management is essential. If the trade is not working, exit.
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