This is what happens when too many people stand on the same side of a boat

By Jani Ziedins | End of Day Analysis

Oct 03

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The S&P 500 bounced back violently Monday, adding 2.7% and easily erasing all of Friday’s losses. The index even got close to reclaiming Thursday’s losses as well.

Not bad for a market many had left for dead a few days ago. But that’s the way this usually goes. The S&P 500 only had a single up day out of the previous nine sessions. The crowd largely came to the conclusion the U.S. economy is doomed and they were selling stocks ahead of the inevitable collapse.

But as is usually the case when too many investors find themselves on one side of a boat, it capsizes. No matter what someone believes is coming next, everyone knows the market moves in waves, and after six weeks of brutal selling, even bears should have been expecting a bounce.

And this is exactly what I wrote in Friday evening’s post titled, “The worse this looks, the more I like it!“:

Sure, anything is possible and we could fall again next week, but the next bounce is a lot closer than most people think. The AAII sentiment survey is over 60% bearish and at a 12-month high, while the historical average is all the way back at 30%. If a person believes in trading against the crowd, sentiments has rarely been this skewed in the bearish direction.

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While Monday’s bounce was a great start, the other important factor to keep in mind is the market loves symmetry, meaning as dramatic as the autumn selloff has been, we should expect a similarly impressive bounce off of the lows.

I’m not here to say the bear market is over, and in fact, we could see lower prices over the coming months. But as far as the near-term prognosis goes, remember, the biggest and sharpest rallies occur during bear markets. So even if bears are right, we should still be bracing for further waves of buying and short covering.

I really liked Monday’s rebound, and this bounce has the best odds of succeeding yet. But there are no guarantees in the market and this bounce could fail like the others that came before it. But rather than give up, we pull the plug at our stops and as soon as we are out, we start looking for the next buyable bounce. Sometimes they arrive as soon as a few hours later.

I was looking for the bounce and loaded up early Monday. By getting in early, I’m already sitting on a pile of profits, allowing me to move my stops above my entry points, making this a low-risk trade. If it works, great! If it doesn’t, no big deal, I pull the plug, collect some profits, and try this again next time.

But at this point, this feels like the real deal.

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About the Author

Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two children.