With a few weeks of bumpy market action, including some big declines, it might seem like a stock market downturn is coming. Everywhere you turn, people are trying to time the market. When will it finally break down? Can I get out of the way before a collapse?
Is a stock market downturn coming?
First of all, we are not expecting to see a collapse or a crash of biblical proportions.
Second, it is not practical to try and time a market move. The best way to make money trading stocks or options is between the tops and bottoms. The trend moves in those spaces are the most powerful and profitable.
Back to those “top callers” who are trying to predict a stock market downturn.
For weeks, every peak is followed by some selling. This is the signal all have been waiting for, they say.
But the market tells us when a downturn will occur and that signal is often difficult to read. The last peak is the most bearish one, and the peaks we encounter along the way simply lead to buys on pullbacks.
Certainly the market will turn down at some point, but we need to see the evidence in order to follow such a bold call.
Indicators will tell you – not people
What sort of evidence? Technical signals and indicators of course. We would need to see:
- A crossover in the MACD from bullish to bearish (confirmed)
- Higher volume moves to the downside on multiple days, which signal distribution
- A turn down in momentum indicators, such as the relative strength index or stochastics
- A bearish signal in money flows
These are the ingredients that may forecast a down move, though nothing is ever 100% correct. However, we have used these signals over time with great success.
(If you want to learn more about reading charts and technicals, join me and Dan Ushman from Trendspider.com for a free options trading webinar on Wednesday. You can register here.)
Bottom line: trying to time a top and predict when a stock market downturn is coming is not a healthy exercise.
Instead, focus on following the signals so you can be prepared. If you do see a downturn coming, manage your risk, raise cash, and buy put protection.
