On Trading Bear Markets

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Bear and Corrective Markets

A bear market is tough to trade if you don’t understand the fundamental trading adaptations that must be made to trade it effectively.

Shorting in bear markets ain’t easy or for the faint of  heart.

However, if you know what to look for and are patient and strategic, they will lead to outsized gains in a market where most traders are losing.

There are a couple of common themes in bear markets that every traders must know in order to succeed. 

Opening Strength Fades

The first principle is opening strength tends to fade. Many of the ugliest days during a bear market come from a strong gap open that fails mid day, and by the end day trends down big. These are often called “bull traps”.

Be wary of strong opens in down trending markets. I tend to wait until late mid day or near the close to initiate positions. This keeps me from grinding down my account by continually getting caught in bull traps.

There is a disadvantage to this cautious approach to morning strength. Occasionally morning strength leads to a powerful bounce. You will miss this move, and it will frustrate you.

However, the money you save are worth missing these types of moves. If the bounce is truly sustainable, you will get other opportunities to enter, including at the end of the day.

Powerful Bounces

This leads to the other common theme of bear markets. Bounces within a bear market are very powerful, often more powerful than up moves during bullish trending markets. You must trade carefully around these bounces.

These power bounces can crush you.

My approach is to trail my stops on winning short positions so I don’t give up too much of my hard earned gains. I’ll then flip to longs and take quick profits when the big spike comes.

Keep an eye on resistance levels. That’s where these bounces will fail, and fail big, Now you can re-establish your short positions. This is exactly what I’ve been doing in the 2018 October-December bear market.

While this is happening, keep a close eye on market breadth during bounces. Bounces that continue to show weak market breadth will fail and continue the down trend.

When Bulls Are Back

However, if you start to notice improvements in market breadth, start researching your relative strength lists for the best stocks to play if the market gets back on an uptrend. As market breadth improves, it becomes more and more likely the bounce will sustain itself and not put in another “dead cat bounce” failure.

At this point you’ll also start to notice that morning strength no longer regularly fades. Instead, they continue throughout the day. That’s when you know you the bear market is over.

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