Why smart money was buying Tuesday’s midday rally

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Tuesday was another turbulent session for the S&P 500 as the index swung between 50 point gains and losses. Unfortunately, bears won the day and the index closed at the lowest levels since last summer.

The price action appeared encouraging after Biden announced a ban on Russian oil imports and the index surged 120 points from the early lows. That midday resilience went against what most people were expecting and unexpected strength is typically a really good sign. But that contrarian move proved short-lived and the index quickly gave back all of those gains and then some by the close.

While this extreme volatility is unnerving a lot of traders, the market doesn’t need to be scary if we come prepared with a sound trading plan.

As I’ve been saying since the start of the year, sell the dips and buy the bounces. While that sounds blindingly obvious, most people end up doing the exact opposite and that is why so many people struggle to make money.

As I wrote yesterday, I locked in profits last week when the previous bounce hit its head on 4,400 and undercut my trailing stops. That means I’ve been looking for the next buyable bounce ever since.

Tuesday’s midday bounce looked good, really good, and so I pulled the trigger on a partial position. (Start small, get in early, keep a nearby stop, and only add to a trade that is working.) When the rebound kept going, I  moved my stops up to my entry point, giving myself, in effect, a free trade. At that point, no matter what happened during the rest of the session, I was covered.

And as luck would have it, the selling resumed and I got dumped out near my entry point. Boooo!

While cynics laugh when people buy bounces that don’t work, I look at this as a free lottery ticket. If it works, I make 200 or 400 points when prices bounce back near recent highs. If the trade doesn’t work, I’m out at my entry point, losing nothing. 400 points of upside with virtually no downside? Only a fool ridicules that trade. (And lucky for us, the market is filled with fools. If it wasn’t, it wouldn’t be nearly this easy to make money.)

While Tuesday’s bounce didn’t work and I’m back in cash, I will be back at it again on Wednesday. And if that doesn’t work, there is always Thursday.

One of these bounces is going to work and I don’t want to miss it.

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