Trend Changes are a Process
At the end of last Thursday's stock market close, the final minutes of trading signaled a quick turn around from relatively bullish to bearish action. Granted, breadth was quite poor during the day which called the strength of the indexes into question, but nonetheless, price action was in the green most of the day. In the final ten minutes, selling kicked in, likely exacerbated by the HFT machines, taking the indexes back to the morning lows, and in some cases exceeded them. Selling like that, when viewed on a 5 or 10 minute candlestick chart, sets up a down open the next day almost every time. Think of it as the "smart money" jumping ship before the potential storm overnight.
Sure enough, Friday morning opened sharply down. If you were positioned for a down open on Friday morning, things were looking great early on (I was, and it did look good, BUT, I still got a horn in my...). Then, within the first 10 minutes of the open, buying kicked in and didn't slow down, taking out the morning highs and then some before leveling off and staying steady most of the day. Remember, tops and bottoms are a process, creating wild swings of seemingly random action for a few weeks time. One day can be straight down with relentless selling, and the next morning opens up 2% and keeps running higher all day. Other day's are prone to quick intraday reversal's that catch many traders on the wrong side of the action. Sure, this is a tough game to follow and random enough, but when you think of the psychology behind it, "random" becomes a bit more clear. During a top, those who've stayed on the sideline waiting for that pullback that never happened on the way up start getting anxious as the first bout of selling kicks in. The initial selling pressure is a bit scary and those waiting for the pullback are now hesitant to pull the trigger. As support levels become noticed, buyers step in slowly to see if the shorts will cover, and early in the process, it's typical for shorts to cover quickly in case the dip buyers do in fact show their horns.
All that means is bears are testing the bulls to see if buying has dried up, and the bulls are testing the bears to see how far they will press their shorts. If support levels break, bears are in position for winning, however if support holds and momentum picks up, another leg higher is in the cards for the bulls. It's a back and forth game, and the team with the most momentum typically wins out in the end. That is why, contrary to mainstream belief, markets don't just fall out of the sky and run to the bottom all at once. There is a process that must play out before a true trend change occurs. Same concept for a bottoming process. This is why bearish and bullish divergences are key to spotting what is happening underneath the price action.
Keep perspective as sharp swings in price play out during times of heightened volatility. Know your strength and if you feel frustrated by the action, don't initiate any trades. No one says you have to trade, and if you are uncomfortable, step away from the screen for a while, or just call it a day. For those with a longer term view who don't care to play the day to day swings, use these selloff's to your advantage. Scale into stock's you wanted to own during the recent run up but didn't want to pay that premium for them. Regardless of your preferences, in the end, there are no bulls and there are no bears. There are only those on the right side or those on the wrong side.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.