The markets have served up an enticing double bottom on a silver platter. How should you trade it? Well, that depends always on your risk preferences. I can identify at least three entry zones, each with different risk reward profiles. Of course, you can be bold and buy and hold, but then here's your chance to buy low and sell high.
What are the Entry Zones?
As I have outlined in Chart 1, you could buy the lows, or wait for the market to clear the dotted down-trend line, or wait for the market to close say 3-5 days above the two reaction highs above 13,000 on the $NYA.
What are the Risks?
First, this is not 2008. I show this using daily data on Fidelity Select Funds, which cover all the major sub-sectors in the market, to construct a trend-weighted breadth, which ranges from -100 (bear market) to +100 (bull market). I then compared about 2-years of daily data: the two years 2006-2008 (red line below) to the 3/2016-3/2018. Intuitively, trend weighted breadth does not look like 2008, and is safely in the green zone. So, the double bottom looks enticing.
Chart 2: This 2-year trend-weighted chart using the Fidelity Select universe shows that the current market conditions are safely in the green zone, unlike the red-line from 2006-08. Any drop below zero would be a concern.
Second, volatility is relatively well contained. There is a small double-top around 25, and any expansion above 28 would be a sign that another leg down is underway. But, for now, the retest of the February lows is occurring in an orderly way.
In my post on down-side targets, I had used the Dow 30 average, which is the weakest of the major indexes. Using the D30 again, we can see that the risk is between -2.5% to -4.5% approximately from current levels.
Chart 4: The down-side risk is on the order of -2.5% to -4.5% or so, and the lows will be well established after the CTM drops below 20. As always, these estimates are only a guess, and the markets will do what they want.
As the Facebook decline showed, the head-line risks in the market have increased, and all the chatter out of nation's capital and central bank actions have not helped soothe traders.
What is the potential reward?
I used the $NYA and its early February high as the up-side target. Here is my best guess for the potential gains up to the old highs using the three entry points. The market could progress past the old highs, but it could take a while to get there.
What Wisdom of the Crowds?
During my appearance on Tom and Erin's show earlier this month, I suggested the poll question, "Will the market make a double-bottom?". Well the crowd split 50:50, and yet, here we are. The lesson here is to follow your instincts, and ignore the crowd. And yes, I am part of the crowd!
I hope you enjoyed this analysis of the potential risk and rewards of trading this double-bottom, and let me know what you think the market will do next.