We had quite the drop over the last 3 days, and I want to touch on how I view the potential for a market recovery. Volatile days like yesterday can be painful for many investors, but when we step back and take a big picture view, they often set up great opportunities, as well. The key is to try to figure out how and when to step into the market.
As I always say, I hate catching a “falling knife”. Even if I think the magnitude of the break is irrational, markets have proven time and again that they can become even more irrational. Traders panic, and algorithmic trading machines are designed to try to make people choose irrational behavior over rational when they see someone in pain.
For me to get a sense of when we could see a potential bounce back in the market, I look back at the last few months. Markets often repeat patterns, particularly as algorithmic trading programs are based upon historical patterns. So, let’s look at a chart of the last 6 months for QQQ (and I chose QQQ because it has been the market leader for a while now):
I’ve highlighted two particular falls in the market: December 3rd, 2020 and January 27th, 2020. In both cases, we saw a big fall, and the market didn’t immediately bounce back. Rather, there was a period of about a week where the markets consolidated, allowing for people to clean up positioning and make their final determination that the break was over.
Should we then expect an immediate recovery in the markets? Probably not. Instead, I will be looking for a few days of stability to reduce the fear and panic in the markets, and then as we see markets start to trade near the upper end of that trading range, I can become more confident in building long positions that play off a resumption of the overall uptrend these markets have seen.
For now, though, I prefer to study the charts, manage my risk, and wait for a better time to deploy trading capital.