Matt Baker |
After most bear markets, we usually see a period of the market trending sideways. But what does ‘sideways’ really mean? A sideways market is one that goes neither strongly up nor down, but just drifts along more or less in a channel. There are however periods within the channel where the market goes up or down strongly, but when you average out the gains and losses over a period of time, perhaps a couple of months, the market hasn’t made or lost much ground.
I wanted to revisit some market action from earlier this year, as I covered it in some detail at the time. Despite the time difference, you will see that the current patterns we are seeing are relevant for the argument I am making.
I looked at the market as at January 28th 2009 and tried to determine whether we were in a sideways pattern. Below is a chart of the SPY (S&P500). Whilst the Dow Jones Industrial Average (INDU) is the more common Index to look at when assessing the overall market, there are only 30 stocks in the DOW. The S&P500 contains the top 500 stocks (including the ones that are in the DOW), so by using the SPY we get a much broader view of the market.
Chart 1
click to enlarge
Without any indicators on the chart at all, can we see the general direction of the market? It could be argued that there were two trends here, one short term and one medium term. Before you read on, it’s good practice to look at a chart without any indicators. Have a close study of the chart above and see if you can see the two trends.
On chart 2 below, I will zoom into the period from October 2008 until January 28th 2009, and place support and resistance lines on the chart.
Chart 2
click to enlarge
If we look in between the solid lines, we can see the market had been in a sideways trend since late October 2008. I found the stronger channel to be between 80 and 95. I also saw support and resistance at the 85 and 100 levels (dotted lines) but didn’t find these as strong as the channel from 80 to 95. The SPY did break and close lower than 80, but only for one day: the following day the market rebounded up and closed almost right on 80, confirming the strength of this support. On the top side, although 100 is a strong psychological resistance area, it is still quite a distance away from where were at – the market would have to go up about 20% to make it there!
So by looking at this chart, perhaps we could conclude that we are in a sideways pattern between 80 and 95 on the SPY. But what about the short term trend? Markets that move within a channel commonly bounce off their channel exteriors – their support and resistance lines, and given that the SPY has recently bounced off the 80 level, it could be on its way up now to the 90 region, and possibly bounce off 95.
Is there a way to trade this? Certainly! With options there are endless ways you can construct trades to make money in the direction you want, or perhaps in two directions. You could also construct a trade where you made a little bit of money in one direction, more in another, and had the risk in the third direction. In the case of the SPY, in constructing a trade in this style, firstly decide where you think the market won’t go, and put the risk there. In this example, if we thought the SPY was not going below 75, we could put the risk down there, have the main profit area between the 80 and 90 region, and a small profit area from 90 and above. What sort of trade can do this? The Butterfly! There are many variations of Butterflies, and this particular trade could be the Modified Butterfly or a Broken Wing Butterfly. The Masters ICT course goes very deeply into Butterflies and how to trade them – a must for every trader.
Manage your trade plan!
Matt Baker
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