Identifying a Market Bottom and Swing Trading Market Cycles
Stock Market Cycles and Their Impact on Our Favorite Strategies
One of the keys to our success in swing trading stocks is using the right swing trading strategies for the current market.
The market tends to go through phases over time that we can categorize and use to our advantage.
You have a correction, a market bottoming process, confirmation of a trend change back to the upside, trending near and above new highs and then another topping process into the next correction.
This next correction generally occurs several months to years later.
Identifying a Market Bottom
A correction is characterized by an emerging risk factor that will affect corporate earnings, a lot of volatility, along with policy measure responses being worked out by the Fed and government (here and around the world).
Stocks test areas of support to find price levels where selling is exhausted and more buyers finally start to step in. This generally takes a few weeks or more.
Stock prices go down because you have more shares of stocks being sold than buying demand at the current price range at the time.
The efficient market theory says that all known factors affecting future earnings streams are priced in at any given time. The problem with that theory is that most long-term buyers are institutional money managers.
One Reason Why Stocks and Market Averages Trend
Institutional money managers cannot buy or sell all at once. They have so many shares (they invest money for thousands or more individuals) of any given stock that they have to buy or sell over days, weeks or months. This partially explains downtrends that develop instead of binary price levels.
If a mutual fund, hedge fudge or pension fund tries to sell their entire position all at once, they often push the stock price too far in the process. They end up getting out at a lower average price.
So they sell over days, weeks or months instead.
So, for instance, Microsoft does not sell at $170 one day and then exactly at $195 the next day all day long after good news is released affecting the value of the company.
Large investors have to scale in and out over time which helps to create a smoother trend between these price levels if enough shares are being bought and sold. Traders are often just playing the institutional sloths over time to make money.
The key is to look for the signs that the institutional investors are starting to unwind or acquire a stock. For this, we can turn to technical analysis to identify trends, trend change signals and confirmations on different time-frames, support and resistance, etc…
A Classic Bottom Signal
A bullish confirmation signal is one of the market bottoming signals we look at. However, this can lead to jumping in too early too often when starting to get more aggressive on the long side.
One of the best ways we know of to identify a market bottom is to look for a double bottom or 1-2-3 trend change along with a break above a downtrend channel on one of the major indices. Usually, the Nasdaq, S&P 500 or NYSE index.
Some of the best bottoming opportunities at that point are good technical entry points out of strong consolidation patterns on top growth stocks. We want to focus most on the ones in great multi-year uptrends.
Just before and (generally) months after the market bottoming signal, you can find great consolidation pattern breakouts on these top stocks in the market.
Cup with handle patterns, high tight flags, large double bottoms on a weekly chart, and great entries near the bottom of multi-year uptrend channels are the way to go.
We are also on the hunt for explosive bottoming patterns and large triangle patterns within a multi-year uptrend on top stocks.
2020 is another great example of this. After the bullish market signal reported in the Daily Alert service at around the beginning of April, we saw several top growth stocks make 15% to 100%+ moves higher within several weeks.
Buying these stocks on the way down before the market confirms a new uptrend means stomaching some pretty high volatility as the market whipsaws back and forth. This very often leads to buying a stock on the way down only to watch it go even lower even if it does develop a bullish consolidation pattern.
Dangers of Buying Before the Trend Change Confirmation
Hanging on to a big loss can be devastating to our swing trading account while the correction is in full swing. A 30% loss means we have to make over 42% on the next trade just to break even. A 50% loss means you need a 100% profit just to break even on the next trade.
Meanwhile, a 9% loss can be recovered with less than a 10% profit on the next trade. So, when trading, we need to have a high win rate while using a fairly tight stop-loss with a lot of upside potential to make it worth our while.
Volatility can crush a trading account. This is why penny stocks are so dangerous. One halt, a short squeeze if going short, a secondary offering after hours (or even during the market day), can be hard to recover from. Especially with the lower win rate over the long-term with stocks below $20 versus trading top growth stocks.
So waiting for the market to confirm a new uptrend and then buying great stocks breaking out of strong consolidation patterns in great multi-year trends with a catalyst is the way to go in our opinion.
In our experience, waiting for the market bottoming signals first gives us the higher win rate with a tight stop and big upside potential. This allows us to trade with more confidence so we can sleep well at night with a larger position.
When the Big Money is Made Swing Trading
After the market has confirmed a new uptrend, you generally have quite a few great swing trading opportunities on top growth stocks.
After the small double bottom on the Nasdaq at the end of March and the 1-2-3 trend change on the S&P 500 when we went bullish at the beginning of April, the top stocks that were well-positioned given the pandemic were ready to make big moves.
LVGO broke out of a bullish cup with handle pattern soon after the market indices confirmed a new uptrend. LVGO is a young growth stock with much needed tele-health services during a pandemic like this.
We featured LVGO near the technical entry point in the Daily Alert before it soared nearly 100% higher within about a month. Buying on the way down during the market sell-off would have meant hanging on to a 20% or more loss wondering where you should stop out a big loss.
Once LVGO developed a bullish consolidation and reached a good technical entry point after a new market uptrend was confirmed, the price reached the technical entry point and soared.
Why Trend Changes and Technical Entry Points Matter
This is the critical thing to understand as a trader. LVGO soared while pulling back less than 3% below the technical entry point. A 100% potential upside while pulling back less than 3% below the technical entry point. A great risk/reward.
Another example featured to clients was DXCM in early April which formed a bullish cup with handle pattern and reverse head-and-shoulders.
It reached the technical entry point given in the alert service and soared 50% within about a month while pulling back less than 4% below our technical entry point which is key. CHGG, NOW, TDOC and many others were all featured before making strong moves higher within a few weeks while holding a tight stop.
A few stocks broke out ahead of the market bottom. We featured ZM in March ahead of a good technical entry point. After it reached that point, the stock soared nearly 30% within a couple days while pulling back less than 6% after reaching the technical entry point.
Before the market indices confirm a new uptrend, we focus just on stocks that are in industries that can buck the overall market trend at the time such as video conferencing software.
The bottoming process and new uptrend confirmation is also a good time to look for good explosive bottoming patterns. We mentioned FVRR in an explosive bottoming pattern in April to clients.
You have to give these bottoming patterns a little more room with volatility more than twice normal levels, but FVRR reached the entry point and quickly doubled in price within a few weeks.
The 3 Stocks to Wealth strategy also often has a big run once the market generates a higher swing low and higher swing high.
After this occurred at the beginning of April, the 3 Stocks to Wealth strategy had one of its biggest 2 month runs ever.
Strategies after the Market Makes a Strong Initial Move Higher
After the market uptrend gains a lot of traction and reaches escape velocity, we continue to see some great consolidation patterns on top stocks. If they develop another good, long enough consolidation and reach a good technical entry point, we get interested in another potential trade.
In the next blog post we will be discussing our favorite strategies for the phase of the market cycle we are in now. Strategies including the most bullish technical pattern – high tight flag.
The same pattern many of the biggest market winners will break out of ahead of enormous moves over the following 2 weeks. A couple recent examples over the past few weeks are DKNG and MRSN before the stocks soared 30% to 100% within several days.
One of the biggest advantages of the high tight flag is that they tend to make a sizable move so quickly. 10% wtihin a couple days can be much better than 20% in 2 months when using a strategy with a great win rate.
Its powerful because the win rate is high during most market conditions and even the modest winners tend to make the move higher so quickly.
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