I heard from somewhere that typical stock market pullbacks are around -8% to -11%. So far, the S&P 500 has pulled back -5.86% from its recent all-time high. So, statistically, we may have a little more to go.
Let’s review the SPY daily chart to start with.
Price is down 6 days in a row which is uncommon. It has not happened the past year. But we have had a situation where price has fallen 10 out of 12 trading days. See the green arrow.
That was the October 2023 bottom after which we had the 5-month bull run. Yes, we had oversold conditions then as seen by the RSI. And we are close to oversold conditions now. So, should we expect a similar bull run now?
Not so fast. Let’s look at the expanded daily chart for SPY.
This is the same chart as above but showing daily bars from July 2023 instead of October 2023. This shows what happened prior to the start of that bull run.
The unprofessionally hand drawn green lines are the lower lows and lower highs that we saw in the price prior to the start of that bull run. Price made 3 lower lows before starting to go firmly higher.
Right now, we may be (not are yet) at our first lower low. I say maybe because the lower low can be lower than where we are now. We expect a bounce back, but we have not seen one and neither have we seen any sign of one yet.
All this to say, we really do not know what will happen. We only know what can happen. And through that we can consider the probabilities of each scenario happening.
Here is my base case scenario (meaning what scenario I give the highest probability).
Event #1: Price bounces soon. It can happen Monday from the current level - meaning Monday close will be higher than current close. But it can also happen after a few more down days. So, we will only know when we see first signs of it. Meaning the first day when we see a higher close from prior day. So, this is our first data point.
Event #2: The price bounce is meaningful. This means the first event of price closing higher than prior closing is sustained by another day or days of higher close. The bottom white horizontal line is the level I am watching now for price to bounce to, so I call it meaningful bounce. That is where I will go “long” with a small position.
Event #3: The price trending has reversed. If price closes above the top white horizontal line, it would have crossed over its prior high. That is when I would call it a price reversal. Here I will go “long” with a bigger position.
Note that between each event we may see price back and forth several times. Meaning it may not be a straightforward series of events. In that case, the price levels for the event criteria will need to be adjusted.
As we saw between Jun - Oct 2023, there were a series of price movements that needed our adjustments of the markers. For people who trade both sides - long and short - (like I do) this is a constant reviewing and adjusting markers similar to how a computer (I mean software algorithm) would do.
Right now, I remain “short” until I see a potential Event #1.
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PS: Note for readers
I have received positive feedback to these notes and wanted to thank you for your encouragement. I started writing these notes for myself so that I can improve my trading and stay focused and disciplined. It makes me happy if others find these notes beneficial as well. Please forward it anyone you know who may benefit as well.