What Magnitude of a Market Drop Are You Willing to Sit Through?

Technical analysts — or “chartists,” as we’re sometimes called — often get a bad name.

And it’s for good reason — mainly because some technical analysts lead investors to believe they can “see the future” in charts, in a “Miss Cleo” fashion.

Technical analysis is an indispensable tool. But don’t think it’s a magic bullet with otherworldly powers.

Far too many analysts make that mistake, placing too much importance on specific support and resistance levels. They incorrectly assume that prices are predestined to stop on a dime and reverse direction only because they hit a line that’s been drawn on a chart. That’s just wishful — and downright dangerous — thinking.

That’s why I use technical analysis of price charts loosely. Instead of assuming I know exactly how markets will react to a certain price level, I make sure to keep an open mind and remain flexible to both bullish and bearish moves.

In recent months, all four U.S. stock indices made bullish breaks to new highs…

  • The S&P 500 hit 2,100.
  • The Dow Jones Industrial Average eclipsed 18,000.
  • The Nasdaq 100 traded above 4,400.
  • The Russell 2000 broke above 1,220.

These were all meaningful moves, showing that the bulls had the conviction and power to push prices above former highs, but bears are currently testing those levels.

Of course, re-tests, pullbacks, and even corrections are normal and healthy components of any bull market. So in the early stages, they’re nothing to worry about.

But in a “slippery slope” fashion, a 5% pullback can quickly devolve into a 15% correction. And sometimes those 15% corrections end up triggering bear market drops of 20% or more.

The key, I’ve learned, is to decide in advance what magnitude of a drop you’re willing to sit through… and at what price level you’ll begin taking action to reduce risk.

For now, I’m not worried about the price weakness we’ve seen since last week. But there are some price levels I’m keeping an eye on. These are…

  • 2,020 on the S&P 500 (must hold above 2,000).
  • 17,500 on the Dow Jones Industrial Average (must hold above 17,000).
  • 4,200 on the Nasdaq 100 (must hold above 4,100).
  • 1,180 on the Russell 2000 (must hold above 1,150).

Overzealous technical analysts might see these “support zones” that I’ve identified as guarantees… assuming that buying at these levels is a sure bet.

But I’m far more humble and bent toward keeping an open mind. I don’t see any “magic” or “guarantees” in these prices levels. Instead, they’re simply price levels that are likely to pull the bulls and the bears out for a vicious game of tug-o-war.

When that battle begins, I’ll watch closely for clues to which side has the upper hand. And then – only then – will I draw my own conclusions on which direction (bullish or bearish) we should be tilting our portfolios.

Be sure to stay tuned for word from me if we hit any of these levels.

Adam-ODell2
Adam

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Categories: Markets

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.