Introduction
This article is written for swing traders with a relatively short time horizon.
3. “What to do when the overall market begins to decline” is not a description of what mid- to long-term investors should do when the stock market reaches a ceiling. Please note that although the description recommends early loss cutting, it is the opposite of what you should do if you are a long-term accumulation investor in indexes or a long-term holder of high-dividend stocks.
As for “4. Preparing for the Next Up Market,” I think the content is useful for both short-term traders and long-term investors.
The peak of bull market
This article was written in January 2022, when the bull market reached its ceiling at the end of 2021 and the bear market began. I would like to organize it so that I can properly identify the rising market that will come again someday and its ceiling.
Summary
- When the leading stocks that had been driving the market higher for several years begin to show abnormal movements, it is the beginning of a turning point.
- When recession-resistant stocks, such as gold, silver, food, tobacco, electricity, telephone, rise at the end of a rising market, it indicates the final phase of the bull market.
- Leading stocks start falling first. The most profitable decline in short selling comes about six months after the ceiling is reached.
Words from U.S. Equity Investment Books and my analysis
William O'Neill - from O'Neill's How to Make Money in Stocks
Next to the average stock price, the most important indicator of a major change in market direction is the movement of the leading stocks. When the majority of individual stocks that had been leading the market begin to show abnormal behavior after years of upward price movements, you can be sure that the market has reached a turning point.
Looking back in the past, in February 2021, the growth stock (ARKK ZM PTON CRWD) that had led the 2020 bull market began to turn around, and in November 2021, the remaining growth stock (DOCU ADBE NET ZS) further began to decline and adjust. In hindsight, I believe that the market turnaround began about a year ago, in the first half of 2021.
IPO - reached at the peak in February 2021.
ARKK - Reached at the peak in February 2021.
WCLD - reached at the peak in November 2021.
Percentage of NASDAQ components above 200-day moving average - highest in February 2021
If, after two years of a bull market, we see rallies in industry groups such as gold, silver, tobacco, food, groceries, and utilities such as electricity and telephone, we may be approaching a ceiling in the overall market.
The week of January 17, 2022, was the first week in which the overall market began a clear decline. The only stocks that have resisted the decline have been food and beverage, tobacco, and telephone stocks, while oil and metals stocks, which had performed well in the first half of January, have also begun to fall. Gold and silver prices have yet to make strong gains, but the market as a whole has reached a ceiling and is now in a full-blown correction.
- Tobacco (PM MO) - highest in September 2021.
- Food (FLO KO MDLZ) - highest in January 2022.
- Grocery stores (KR) - highest in January 2022.
- Telecommunications (T VZ) - highest recent price in May 2021.
- Utilities power (DUK SO) - highest in August 2021.
- Gold, silver (NEM GOLD AG) - highest price in August 2020. No major rises yet as of January 2022.
PM
MDLZ
KR
DUK
GLD
T
In the early stages of a bear market, certain leading stocks are strong, as if resisting the downtrend, giving the impression that they can rise. However, this is merely a reflection of defying the inevitable doom of a decline. When a full-fledged decline eventually begins, no stocks can escape it, and eventually even the leading stocks will succumb to the selling phase without exception.
The above trend began in December 2021 and the first half of January 2022. GOOG, MSFT, and AAPL, which had been rising steadily while many of the high-tech growth stocks were falling, finally began to fall.
Investors who use charts to understand market movements know that there are few leading stocks that look attractive near market ceilings. These are times when you simply don't see a single stock breaking out of a correctly formed base. The time to buy the best stocks has long since passed.
As of January 2022, exactly as described above, many of the best stocks have also been caught in an adjustment and their charts have begun to collapse, and only a few stocks are forming patterns in an uptrend that we would like to enter.
Almost all of the patterns of big short-selling have emerged five to seven months after a previously fast-growing leading stock had clearly hit a ceiling, which means that the short-sellers have been able to sell off the stock for a long period of time.
ARKK hit its ceiling in February 2021. Nine months later, in November 2021, the decline accelerated, and we should assume that high-tech growth stocks that hit the ceiling in November 2021 are at risk of another accelerated decline around March 2022 if the ceiling is reached in five months, or May 2022 if the ceiling is reached in seven months.
What to do when the overall market begins to decline
As of January 2022, the market has reached a ceiling and is beginning to decline, but here is a summary of what to do during an adjustment phase or bear market.
Summary
The following two points are a short summary of what swing traders should do when a falling market begins.
- Withdraw from the market while losses are small without making any further purchases.
- Do not buy stocks that have fallen sharply, thinking they have become inexpensive.
Words from U.S. Equity Investment Books and my analysis
Mark Minervini - Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market
If a leading stock that has led the market for a long time hits a major ceiling, there is a 50% chance that it will drop 80% and an 80% chance that it will drop 50%.
The percentage decline from the highs of the high-tech growth stocks that drove the post-covid shock market from 2020 to 2021 is shown below.
- PTON -84%
- UPST -77%
- ZM -74%
- AFRM -67%
- ARKK -55%
- NFLX -43%
- ADBE -29%
- AMZN -25%
- GOOG -15%
- MSFT -15%
- AAPL -10%
As of January 2022, ZM, PTON, and UPST are already down around 80%.
ARKK and AFRM are down 50-60% at the moment, but there is a 50% chance of a drop to 80% from here. As for ADBE AMZN GOOG MSFT AAPL, which has recently started to decline, it is a difficult phase to enter, considering that there is an 80% chance of a 50% drop from the highs and a 20% chance of a rise or sideways move in the future.
If you “average down” when a stock is going down, thinking that this stock will go up again at some point, you will be psychologically beaten down by the unrealized losses that continue to swell, and eventually your trading account will take a major hit.
If you continue to average down stocks that are showing signs of beginning to fall because they have become cheap, if the earnings results do not meet your expectations, you risk a sharp drop in stock prices and large losses in a market environment where investor sentiment is also not good.
Make no mistake, do not think of a sharp drop in stock prices as a buying opportunity. Many investors fall into this trap. Their holdings suddenly plummet. They think the market must be wrong. They assume that their holdings are still rising steadily and decide it is time to buy more.
This week and next week, 4Q2021 earnings announcements will begin in earnest, and there is a risk that some stocks will fall as sharply as Netflix. I would like to keep in mind not to get involved in stocks by mistakenly believing that they have become undervalued.
Even if a company does not go bankrupt, it often suffers from a significant drop in stock prices. And after a drop, it can continue to level off, and positions can remain in an “unrealized loss” state for years, even decades in some cases.
I will include two examples of stocks that have fallen sharply that were mentioned in the book.
LL Flooring Holdings, Inc.（LL）
LL Flooring Holdings, Inc. (LL) has briefly returned to $30-40 since 2016 after a 90% drop from its high, but in the end, eight years later, it is still not far from its high at the end of 2013. This chart shows that it is a very dangerous bet to buy stocks that have risen in a temporary boom and then returned to their original prices, thinking they are now cheap. (PTON ZM AFRM UPST, etc.)
Cisco Systems, Inc.（CSCO）
Here is a chart of Cisco Systems, Inc (CSCO). From a price of $11 in 2002, down 90% from its high, it was up 140% by 2004 and back up 420% to $56 as of January 2022. The result is a reasonable return if you can pick it up at the bottom, but it is not a very efficient investment considering the holding period.
Preparing for the next rising market
So what should individual investors and traders like us do during the start of a bear market like the one in early 2022? I have picked up what you should do from two books.
Summary
Ideally, with a loss pulled up to cash at the start of the decline from the ceiling, this is the time to prepare by monitoring the index charts to determine the market bottom, while looking for stocks that will be candidates for entry during the next up-market cycle. We will also consider buying more index investments during declines.
- Look for stocks that are holding up without a major decline while the overall market continues to fall.
- Look for stocks that get out of the way quickly and start rising while the overall market is flat after a decline.
- Observe the average price of the overall market and determine the bottom of the market.
- If you are buying index investments or mutual funds, buy more when they drop 30%.
Words from U.S. Equity Investment Books and my analysis
Mark Minervini - Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market
The best stocks bottom before the stock indices do. When the major stock indices are making lower lows during an adjustment phase, the leading stocks bottom first and make higher lows. Stocks that hold up best amid a general decline in the stock market and are within new highs during the first four to eight weeks of a new up-market are true leading stocks and can be expected to rally significantly.
When the overall market bottoms, the leading stocks that have withstood the decline the best begin to rise first and break above the base. Most investors are unaware of this phenomenon and refuse to acknowledge that this is a buying opportunity for leading stocks.
The following are stocks that we would like to find at a time when the overall market is coming out of a declining market.
Apple (AAPL) in 2004
While NASDAQ failed to rise from 2004 to 2005, AAPL rose 290%.
Netflix (NFLX) in 2009
Netflix rallied significantly during a period when the overall market was flat after a decline in late 2008.
William O'Neill - from O'Neill's How to Make Money in Stocks
Regardless of the size of the correction, the market will always try to rally at some point. Jumping on the wave in a hurry at that point can be painful. Wait until you are sure that the market has entered a new uptrend.
After the fourth day of the test rise, observe whether any of the major averages continue to rise on significantly higher volume than the previous day. If this occurs, the likelihood that the rise will be genuine is even higher. The strongest rallies usually occur on the fourth to seventh day after the rise begins.
Remember, no new bull market has ever started without proof of strong stock prices and volume growth. There is no harm in patiently waiting and listening to the market.
This is a chart of the bottom of the NASDAQ in 2003. The key point is that volume is well above average on the fourth day after the close above the previous day's price.
If the economy continues to be sluggish or the newspapers and television are reporting poor economic conditions, you should consider putting additional money into the fund when it has fallen 30% or more from its highs. If you feel the bear market is already over, you may be willing to borrow a little more money to increase your purchases. If you can wait patiently, prices should rise steadily over the next two to three years.
If you have been accumulating index ETFs or purchasing similar mutual funds, your strategy would be to invest your money in a diversified fund with a target decline of 30% or more. Right now, QQQ is down around 13%, so you may want to wait for it to drop another 20% or so before resuming purchases. $260-$280 is a good target for QQQ.
Finally.
Thank you for reading to the end. There are three things to do when a bear market begins
- Identify market ceilings and withdraw quickly before a major decline, and
- Waiting patiently for the market to bottom out while looking for stocks that will drive the next upward cycle
- Entering a leading stock only after a reversal from the bottom is confirmed.
It will be difficult to do this perfectly, but I will continue to monitor charts, earnings announcements, and market news so that I can do so with as much accuracy as possible.
I hope this will be of some help to you in your U.S. stock trading and investing.
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