Momentum, Trend and Swing Trading a Sideways Market
Stocks shook off a bout of aggressive selling early on Thursday to close significantly higher on the day.
While many market observers are anticipating a further breakdown in stocks and still others are eagerly looking forward to the inevitable bottom, swing traders should probably be sensitive to another possibility: that stocks might move sideways — thwarting the ambitions of momentum traders and reversal traders alike.
In other words, if half the people are saying that outcome A is most likely, and the other half are saying that outcome B is most likely, the savvy swing trader remains open to the possibility that neither A nor B, but potentially the undiscussed outcome C might actually represent what takes place.
I won’t pretend not to have a preference for outcome C. Swing trading — especially the sort of mean reversion trading that is a fundamental part of using our Short Term PowerRatings — relies on taking advantage of contradictions in trader sentiment.
Momentum and trend traders tend to look for consensus, instances when the will of buyers or sellers in the marketplace simply overwhelms the other side of the trade, either instantaneously in the form of a breakout, or over time in the form of a new, sustained trend.
Swing trading stocks as they revert to the mean rely on instances when traders are leaning too far in one direction at the wrong time. Our approach to swing trading with PowerRatings involves looking for instances when traders are too pessimistic toward strong stocks (with high Short Term PowerRatings) and too optimistic toward weak stocks (typically with low Short Term PowerRatings).
As I have suggested in recent articles, we have not seen a very large number of these sort of opportunities for swing traders (the exception being in the exchange-traded funds I highlighted two days ago). Unfortunately, Thursday’s trading leaves my opinion little changed on the prospects for successful mean reversion trades. Stocks in general have been driven below their 200-day moving averages, taking the vast majority of long trade opportunities off the table.
I have encouraged patience in the past — and it appears that patience is again the order of the day for swing traders. Of the 25 stocks in our Top 25 PowerRatings stocks roster, not a single one is trading above its 200-day moving average. This, again, is an example of PowerRatings telling as, as mean reversion swing traders, what it is we need to do in order to be successful. And that message, for the time being, remains: wait and watch.
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