By Jeff Clark – the editor of the Jeff Clark Trader
You cannot ride a bear.
Rodeo cowboys score points by staying on the bull as long as possible. Investors profit by doing the same.
But a bear is a completely different animal. No cowboy is crazy enough to saddle up and try to ride a grizzly. Yet investors try it all the time. And, they get mauled.
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Bear markets are not for riding. They’re for trading.
That means you wait for severely oversold conditions before you buy anything. Then you sell when conditions become less oversold.
And you wait for severely overbought conditions before selling stocks short. Then you cover those trades when the market turns neutral.
It’s not a buy-and-hold environment anymore. It’s a scalping environment. Play only the best setups and take profits quickly.
Last week was a great illustration of how bear markets work. Stocks started the week in extremely oversold territory, and drifted even further into the abyss during Monday’s decline. Oversold conditions can get even more oversold.
But, that’s the setup from which bear market rallies occur. And boy, did we ever get one.
In just three days the S&P 500 rallied 15%. That’s the biggest weekly gain for the index in my lifetime.
In the process, many technical indicators went from extremely oversold to extremely overbought. For example, take a look at the following chart of the McClellan Oscillator for the Nasdaq (NAMO)…
The NAMO went from its most oversold reading of the past year towards its most overbought reading – in just three days.
Traders who tried to “ride the bear,” and held short positions into extremely oversold conditions on Monday, got crushed later in the week. Similarly, bullish traders who overstayed their welcome got hurt during Friday’s decline.
In bear markets, traders shouldn’t be trying to maximize the profits of a position. They should be entering trades when the risk is minimal – like buying into extremely oversold conditions and/or shorting into extremely overbought conditions – and then scalping profits when conditions return to neutral.
By holding on to a position in an attempt to capture the greatest possible gain, traders risk watching a profitable trade turn to a loss.
Bear markets can give traders plenty of opportunities to profit. Just remember – we don’t ride the bear. We scalp it instead.
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