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To Buy The Dip Or No

“There is time to go long, time to go short and time to go fishing”  -Jesse Livermore

 

"What happens after a fast, high-volume 2-3-day sell off. There are three major scenarios:


     - a stock move sideways on a low volume as it finally find bidders. Some will interpret this price action as the forming of bear flag. Others will look at it as the forming of a new base, which is an important prerequisite for higher prices in the future as it is likely to attract fresh money. Both groups could be right and that dispute will be solved only by price – in which direction is the stock going to break out from its new range.
     - a stock continues to fall down in an accelerating fashion, breaching all obvious support levels; such action often leads to a sharp V-shaped recovery at some point as shorts decide to cover and new longs enter, attracted by the new price levels;
     - a stock bounces sharply from one of its rising major moving averages, as the 50-day for example. Those that are today’s buyers of those dips are likely to be tomorrow’s sources of selling as time horizons tend to shrink during market corrections. 

It is always useful to watch how the market reacts as stocks correct. It makes a lot of sense not to buy blindly declines to major moving averages at this point, because you don’t know in advance if there will be an immediate bounce. It is better to wait for the stock to form a base. As I mentioned already, some of those bases will be bear flags; some will be a launching pad for another move up."

 

"While it is true that most momentum stocks are still above their rising 50-day MA or with other words, there is no technical evidence that their move is over, we have to be blind not to pay attention to the high-volume selloff last week. Is it the beginning of something bigger or just a temporary setback, designed to flush the weak hands out, no one knows for sure. The major market moving averages are in an uptrend too, by all definition of the concept. The truth is that they have always hidden more than they have revealed. Underneath the surface, small caps were ditched, trends in individual names were broken.

After a few days of high-volume decline, many stocks tend to move sideways. Some of these stocks will form bearish flag and continue their correction; other will build a new base, which will be a launching pad for future price appreciation.

We are in the midst of an earnings season, where every report has the potential to make or break a trend as new information changes perceptions of value and risk. The stock market is a forward looking mechanism that tries to discount proactively and this is one of the foundations of momentum moves. We mentioned on numerous occasions here that most stocks appreciated significantly before the earnings season began and the elevated expectations meant trouble for stocks that did not live to their reputation. We saw $FFIV losing 23% overnight, which essentially wiped out its price appreciation for the last three months.

In the financial market, as in life, reaction to news is far more important than the news itself. The selloff in $AAPL after reporting the most stellar quarter in its history just does not feel right. It is naïve to assume that option pinning has the power to stop $AAPL after such earnings report. The risk appetite on the long side seems gone, at least for a while. One of the major underlying conditions of bull markets is the positive market reaction to almost all type of news. This condition is nowhere to be found today."

 

The above excerpts from @Ivanhoff, Managing Director of Stocktwits50.  Original posts can be found here and here

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