Here are some of the most valuable lessons that you can learn from one of the most volatile week in Dow's recent history. Those who learn from history will stand a chance not to repeat it again in the future.
Even before the market collapses there are lots of signs in the charts that is warning us. Besides technical lessons from the charts, we can also learn a thing or two about how professionals tackle the market.
Plunges, corrections and bear markets are nothing new in the stock market. In any financial instrument we will have the 4 Stages Of The Market. And a financial instrument will go through these stages in many time frames as well.
Let this stock market plunge serve as a reminder to us to heed the warnings and lessons that you are about to discover below.
One of the important lessons that you will have to learn is that bullish run ups do not last forever. The bull market in Dow Jones may not have ended if we look at the weekly chart of the Dow. However, there will be times when the Dow moves up too fast too soon.
When this happens, the fall can be very fast. That is because a fast run up has not formed support areas. There is a void where allow prices to go down in a straight line. Even minor support areas will not be able to hold them because when the Dow plunges 1000 points in a single day, everyone will be very very scared.
The chart above shows how the Dow plunged in less than a week. Just because the market has been running up non stop it does not mean we will always be safe. The professionals know that a bull run cannot last forever. Eventually there will always be a point where the market will plunge very fast.
Another very important lesson that you should take away from Dow's plunge is that professionals sell on the way up. On the other hand, the amateurs will continue to chase the market. They will buy anytime without looking for any continuation patterns.
Professionals know that in order to enter a market that is experiencing a massive bull run, they need to look for continuation patterns. Continuation patterns offers the trader a safe way to enter a stock. It gives them a reference point to know when they should enter and when they should get out if they are wrong.
Some continuation patterns in a bull market include box breakouts, consolidation breakouts and triangles. Whether the pattern appears in the daily chart or the 60 min chart it does not matter.
The amateur will enter only when the market and stock has been very hot.
I run a Telegram Chat Group where I answer question from fellow investors and traders. One of the things I notice is that people tend to chase after stocks that are hot and already in the news.
That is a very terrible mistake.
Remember that when a stock or market is already up a lot, the professionals are already thinking of selling.
If you are someone who aims to catch the exact end of a bull run, then you may be wasting your time. Nobody can really know when the market will stop going up. Sure there are clues to when a market might top out. But how many people can actually time the market to perfection?
The good thing about the stock market is you do not need to know the exact top of the market to make money. You just need to catch the majority of the trend. I am a big believer in trend following and I always tell my readers and members to follow the trend.
In fact, I told them that technical analysis does not make money. It is technical analysis plus trend following that will help you make money.
One of the ways that I try to catch the meat of a trend is to use the 60 min chart of SPY, DIA or QQQ. They are the etf that mimics the performance of the S&P 500, Dow Jones and the Nasdaq Composite.
I use a simple system that I develop to try and warn me of the end of a short term trend. If a stock or index has been rising a lot in the short term, I will switch to the 60 min chart and stay bullish on the index as long as it is above the 60 min 20 MA and 50 MA.
In the chart above, you can see how the SPY stayed above the 60 min 20 MA and 50 MA most of the time as it ran up. Then SPY dropped below the 50 MA into the red zone. The area below the 60 min 50 MA is colored red so that I can easily see it.
Can you see how the entire market collapsed after SPY dropped below into the red zone. This told us that the nice bullish uptrend in the SPY has ended. When that happens, we need to be very very cautious.
What many newbies in the stock market do not know is that the smaller time frames can often hint of what will happen in the bigger time frames. For example, the daily plunge in Dow Jones, S&P 500 and the Nasdaq happened when the 60 min charts of these index's etf formed a bearish reversal pattern.
The bearish reversal pattern that gave a big warning to traders and investors was non other than the 60 min head and shoulders pattern in the QQQ. The QQQ is the etf that represents the Nasdaq Composite Index.
The chart above shows how the QQQ formed a head and shoulders in the 60 min chart. Head and shoulders often warn traders that there might be a possible top. There is a reason why the head and shoulders work so well.
That's because a stock or index that is healthy is supposed to go higher. The right shoulder in the pattern told us that the market did not have the strength to continue to move higher. Therefore, this represents weakness and the trader should be very careful of this when he sees this pattern happen in any index.
Look how much the QQQ fell after the appearance of the head and shoulders pattern.
The DIA above which represents the Dow also made a lower high. In other words, it failed to make a higher high which is the characteristics of indices that are in an uptrend. Remember that the chart above is the 60 min chart and not the daily chart. We are using the price action in the lower time frames to anticipate what will happen in the bigger time frame.
DIA also formed a consolidation box and broke down from it. This sent the Dow lower and drag the entire market.
One of the things that we can learn from the bull run, top out and then the subsequent collapse is human psychology. Warren Buffett once said this "Be fearful when others are greedy and greedy when others are fearful".
I think his advice applies very well to the recent stock market plunge.
The run up in stocks has made many people very greedy. Just like the run up in Bitcoin, the markets will eventually collapse. Which brings us back to the earlier advice of selling on the way up.
Parabolic non stop move up should be met with fear.
When the public is greedy, it is time to be fearful and take some profits off the table.
It never ceases to amaze me how a simple concept like breaking an uptrend line will bring such a big plunge in the stock market. Draw a line and look at it?
Well, if some of the best traders in Wall Street do that, why shouldn't you pay attention to it?
The chart of the S&P 500 futures above show how powerful the trendline is. The S&P 500 collapsed after it violated the trendline. The next time you see your stock doing this pattern, you better start selling it.
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