Monday, February 3, 2014

TechniTrader Weekly Stock Discussion for MetaStock: “Why Stock Market Corrections can be a Good Thing”

MetaStock® SPRS Series - Week 156 – January 31, 2014 - MetaStock Spatial Pattern Recognition Skills Series written by Martha Stokes CMT

After any big down day for the stock market, most of the retail investors and retail traders are very negative.  Most of the time any kind of down day, large or small is viewed as a “bad thing” something to be upset about and worried about.
However this viewpoint is not the perspective of the professional side in many instances.  To gain a proper objectivity on the polar opposite viewpoints of the retail side versus the institutional side, consider the way the retail news reported the Dow dropping versus the professional news. Retail news and retail comments were “Worst week since 2011,” “Meltdown,” and “Good riddance for that week!”
Professional comments were “The markets had been overbought and need to correct,” “Pricing had been speculative for some time,” and “A correction will provide better pricing.” Clearly the two sides of the market view corrections completely differently.  The professional side accepts that corrections are necessary and even good things when viewed in terms of the viability, sustainability, and duration of a Bull Market.
As you can see in the weekly view of the Dow 30 below, whenever the Angle of Ascent™ exceeds the long term sustainable angle of ascent, the market needs to correct in order for the long term trend to continue upward.  If the angle of ascent becomes too steep too quickly the correction will be deeper. If the angle remains stable without excessive price speculation, then corrections are shallower.  At the end of the year 2011, a deeper correction was necessary due to the shallower correction in 2010.  In 2012 plenty of speculative buying occurred that moved the market upward at an ever steepening angle of ascent, with more shallow corrections.  
The steeper the angle is, then the higher the risk of a deeper correction. When the angle becomes extremely steep as was the case for NASDAQ in 2000, than a massive bear market becomes inevitable.
What most technical traders forget is that the over 80% of the market participants who buy stocks are fundamentalists.  They control price most of the time. Their buying and selling dominates charts and sets many levels of support and resistance.  The Dark Pool giant lot investors are predominantly long term investors, and not day traders. That is something most retail traders often forget.  Their goal is to buy stocks that are undervalued based on fundamental research their firms do independently of anything the retail crowd has access to. By the time earnings season is underway, Dark Pools are usually sitting on the sidelines.  
Fundamentalists create their own resistance levels during speculative market action.   The Dark Pool giant lot investors are unwilling to pay more than what they perceive is fundamentally a correct price to pay for that stock.  That fundamental principle dictates for retail and professional chartists where they are most likely to see a cessation of giant and large lot buying.  It also defines how and where the speculative emotional buying of smaller lots instigates a correction or a topping formation.
By understanding the underlying dominant force of the fundamentalists, technical traders can more easily determine when a true correction will be the beginning of a bear market or when a correction is merely a short term event.  Certainly the retail news will always find some reason to explain the correction, however all corrections start first with the giant and large lot investors halting their buying for that stock, index, or market.  Without their buying activity, smaller lot buyers with their smaller capital bases will be unable to sustain the runs.
The advantage retail technical traders have is the ability to see the angle of ascent rising too steeply indicating speculative smaller lot buyers, instead of giant lot buyers who do not ever create speculative runs. Dark Pool giant lot investors are wise and do not buy into speculative runs, instead they start selling into speculative runs.
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Trade wisely,
Martha Stokes CMT
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Master Rated Technical Analyst for Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader Stock Market Courses
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