How Savvy Bulls Avoided Thursday’s Carnage

The S&P 500 proved again on Thursday that a lot can change in a few hours.

S&P 500 Index, Daily Chart

As I wrote Tuesday evening, everything looked great. An early 1% loss ran out of sellers and turned into an impressive 1% gain. Weak markets don’t do those things and I was content holding for the largely expected continuation to 4,300 resistance.

But hidden at the bottom of Tuesday’s overwhelmingly positive post, I had one small nugget that proved to be all too relevant on Thursday:

Now that the index is back above 4,150, I can spread my stops across the lower 4,100s. If we retest support again this week, there is no coming back from that and lower prices are ahead.

Every good offensive plan starts with defense. If we don’t define our limits up front, we are trading without any and few things are more dangerous to our trading accounts.

As much as I liked Tuesday’s price action, I wasn’t willing to sit there unprotected. If Tuesday’s bounce was the real deal, it wouldn’t retest 4,100. Slipping back to support so soon after bouncing off of it means something is wrong. And as we found out Thursday, when things go wrong, they can go really wrong.

While everyone saw the market split wide open Thursday, most people missed the cracks that were already starting to show Wednesday afternoon. I didn’t like Wednesday’s fizzle and late retreat to 4,100 support. That convinced me to lock in some profits proactively. And Thursday morning’s stumble under 4,100 told me it was a better time to be safe than sorry.

I had no idea the market was going to shed nearly 100 points that afternoon. All I knew is the risk/reward was no longer in my favor. I liked the market and still thought 4,300 was the most likely outcome. But as easy as buying back in is, there is no reason to stick with a trade when it is flashing yellow. Because you know what? Flashing yellow turns into flashing red in the blink of an eye.

While most people were riding Thursday’s waterfall selloff lower, I was in cash and wondering if I should short the market. I was clearly wrong about 4,300, but as a nimble trader, I don’t mind being wrong. In fact, being wrong can be highly profitable if we are savvy enough to recognize it early and flip the script.

If I was wrong about 4,300 and 4,100 support, maybe I should be going the other way because if this breaks down, there is a lot of air underneath current prices. Rather than stubbornly stick to my prior position, I admitted defeat, pulled the plug, and joined the other side. No one likes being wrong, but I like making money a lot more than being right.

As for what comes next, it doesn’t look good. In fact, it looks dreadful. If the market doesn’t bounce hard at today’s open, get ready for more blood letting. Maybe the selling only lasts a few hours before capitulating. Or maybe we shed another 100+ points and challenge May’s lows. Either way, I don’t want to be standing in the way.

But as bad as this looks, the other thing I know is when this bounces, it is going to bounce hard. I doubt that will happen Friday or sometime next week, all I know is when this bounces, I’m covering my short and going long.

Either we ride this market or it rides us. You decide.