Why bears should be taking profits and what to expect next

Free After-Hours Analysis: 

The S&P 500 finished Tuesday’s session sharply lower as the bond market’s outlook dims.

This isn’t the trade I’ve been waiting for. Luckily, my trading plan is keeping me on the right side of the market. As I wrote Monday evening:

I am not a bear by any stretch of the imagination, but if this market is going to bounce, it needs to happen soon. I will buy back in if prices bounce on Tuesday, but I need to see constructive price action first. Until then, I’m sitting on my hands and watching this from the safety of the sidelines. (Aggressive traders can short another breakdown.)

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As readers know, I tried buying a couple of bounces over the last few weeks, and with hindsight being 20/20, obviously, those trades didn’t work as expected. Fortunately, those failed trades didn’t cost me any money because I bought the bounces early and was able to quickly move my stops up to my entry points. As I’ve written countless times, low-risk/high-reward trades are always worth trying, even when they don’t pay off.

I suppose I could have been bearish and profited more from this decline, but optimists amass far more money than pessimists because the market spends significantly more time going up than going down. If I’m going to error, it will always be buying the bounce because those work far more often than betting on a bigger breakdown that only occurs once every couple of years. As much as bears are boasting right now, they’ve been wrong all year. When it comes to trading, I’d much rather be right for 11 months instead of just one.

All of that said, stocks are only down 8% from their 52-week highs, so this still qualifies as a pretty vanilla step-back and something that happens once every year or two. Of course, the alternative interpretation is stocks have “only” fallen 8%, meaning there is a lot more downside if we are truly falling into a bear market.

Are we close to the bottom, or not even halfway? That’s the million-dollar question. But as nimble and savvy traders, it doesn’t matter. We get out of the way when prices fall, and we buy back in when prices bounce. In fact, the lower prices go now, the more money we make riding the next wave higher, so bring on more selling!

The S&P 500 is quickly approaching 4,200 support and the 200 dma. No matter what the future holds, we should expect at least a modest bounce at these widely followed technical levels. Maybe we violate these levels a few days later, but over the next day or two, the odds are good prices will bounce, making this the wrong place to be aggressively pressing shorts.

Wait for the bounce, then follow the market’s lead. Either the bounce will stick, or it won’t. Savvy traders will be basing their next trade on what happens after 4,200.

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