There are only two ways this ends, and how savvy traders are approaching it

Free After-Hours Analysis: 

The S&P 500 gapped under 4,400 support Thursday morning and kept going as Wednesday’s fear trade continued. By the time it was all said and done, the index finished down a dreadful -1.7%. That was enough to make this the lowest close since June. Ouch.

The Fed didn’t say what investors wanted to hear Wednesday afternoon, and that kicked off this 120-point tidal wave of reflexive selling.

There are two ways this plays out: either we bounce, or we don’t. It really is that simple. Since I don’t believe Wednesday’s headlines changed anything, I’m looking for a continuation trade. After this wave of volatility and reflexive selling passes, the market will go back to what it was doing previously, which was consolidating this summer’s gains between 4,400 support and 4,400 resistance.

The thing to keep in mind is the market only changes its long-term trend every other year, give or take a few years. While something this vague can’t be used as a timing signal, it is a useful fact to keep in mind when debating if the market’s long-term trend has changed. If we get 400 sessions of continuation for every one change in direction, the odds always heavily favor a continuation, not a change in trend.

Until proven otherwise, I will continue giving the bull market the benefit of the doubt and will view this weakness as a buying opportunity.

As I wrote Wednesday evening: 

Since the market didn’t pop Wednesday afternoon, that means I’m trading the dip and bounce. Maybe we bounce Thursday morning and never look back. Maybe we fall a little further under 4,400 support before bouncing. Either way, I’m waiting for the bounce and then jumping aboard. The lower this goes now, the more money I make buying the bounce in a 3x ETF.

Just because buying the bounce didn’t work on Wednesday or Thursday doesn’t mean that strategy won’t work on Friday or even next week. The market has a nasty habit of convincing us we are wrong moments before proving us right.

Without a doubt, this could be the start of the next major bear market, and we need to protect our backside because there is no excuse to ride a losing position all the way into the dirt, but until I see something more compelling, I will keep waiting for the bounce. Even if this is the start of a bear market, a bounce is still headed our way because bear markets bounce too. In fact, some of the easiest and fastest money is made trading bear market rallies.

Of course, Thursday’s price action reminds us why only fools buy dips. Low has a nasty habit of getting even lower, and this is definitely one of those times where it is better to be a little late than a lot early. Savvy traders wait for the bounce. Start small, get in early, keep a nearby stop, and only add to a position that’s working.

And if our first, second, and third trades get stopped out? No big deal. We make mistakes with small positions and nearby stops, while we ride the winner with full positions and a far larger profit targets. Follow this simple plan, and the math will work out in our favor.

As I wrote Wedensday, when I’m standing safely on the sidelines, I’m happy to be wrong. Bring on another wave of selling because the lower this goes now, the more money I make buying the inevitable bounce.

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