Where These Hyper Violent Moves In The Stock Market Come From and How They Work
“There is only one side of the market and it is not the bull side or the bear side, but the right side.”
Jesse Livermore
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One of the most violent moves you’ll see in the stock market is a bear market rally. When a bear market rally happens, it can be both confusing and frustrating for traders. That said, these rallies can also be incredible opportunities for the best simple traders. It’s important to understand how they work in order to make the best decisions during these periods.
What Is A Bear Market Rally?
A bear market rally happens when the stock market experiences a short-term period of above-average gains within the context of a strong downtrend [i.e., after a prolonged period of losses]. This is typically defined as a period where the market is up for at least three days in a row, and the gains are strong enough to offset a significant portion of the preceding losses.
Bear market rallies occur for a variety of reasons. Sometimes, they happen because there is genuinely good news that causes traders to believe that the worst of the bear market is over and the low is in. Other times, a bear market rally might kick off due solely to technical factors, such as a period of extremely oversold conditions in the market.
It’s worth noting that bear market rallies are almost always especially violent. Further, it’s impossible to determine if a bear market rally is just an intermediate rally [a rally that won’t break the overall downtrend] or if it’s the beginning of a true reversal [a move that will break the downtrend and return the market to an uptrend].
Whatever the reason, bear market rallies are tough for traders. On the one hand, given that a rally may just be the early stages of a true reversal, it can be tempting to buy into the rally and try to make some quick profits and/or establish a position at a low price. However, there is the ever-present risk that the rally will fizzle out and prove to be a fake reversal allowing the market to continue its downtrend.
How To Trade Bear Market Rallies
The best way to navigate a bear market rally as a short-term trader is to stay disciplined, and focus on your strategy and trade setups. Long-term portfolio traders who have a well-positioned portfolio and a patient time horizon should have no problem riding out volatility. However, whether you’re short-term or long-term, if you’re feeling tempted to jump into the market with neither rhyme nor reason [as do most people at such moments in the market], it’s important to remember that bear markets often have a way of tricking traders into making poor decisions.
If you’re thinking about buying during a bear market rally, be sure to do your homework first. Make sure you understand the true market context, why the rally is happening, and whether or not there is a good reason to believe that it will continue. And, as always, be sure to monitor and control your risk.
One other thing… while bear market rallies can be tricky for traders, they can also be great opportunities for astute traders with the right approach. How that works is beyond the scope of this post, but the gist is short term traders who use approaches that make use of probe trades and/or allow traders to take multiple low-risk attempts at getting into a position can use the activity and volatility of bear market rallies and/or reversals to generate incredible returns for themselves. Alternatively, more advanced traders can use bear market rallies as an opportunity to sell short and make money from the next leg down… especially those support and resistance traders who have a deep understanding of important price zones and how to use them.
Take This With You
In conclusion, let me say this… bear market rallies are temporary periods of recovery during a longer-term downtrend in the stock market. They can be caused by genuine good news or technical factors, and are often characterized by violent price movements. As a trader, it is important to stay disciplined and focus on your strategy during a bear market rally, as it can be difficult to determine if the rally is truly indicative of a reversal in the trend. If you do choose to trade during a bear market rally, be sure to monitor and control your risk. With the right approach, bear market rallies can present great opportunities for profit… whether you trade long or short.
Originally published at https://www.theartofsimpletrading.com.
