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  • The Value of Market Corrections


    Market Overview

    World markets are mostly bullish, although many of them are correcting/consolidating on the intermediate-term basis. Right now, the risk associated with initiating new positions is large - do not try to initiate new long positions. For existing positions entered previously, hold onto your big winners and cut your losses quickly.

    China

    The Chinese stock market is still in the middle of an intermediate-term correction/consolidation. It is trapped in a range and now it seems to be on its way from the top boundary to the lower boundary. This activity will possibily go on for a few more weeks. This is not the best time to initiate new positions as the market is choppy and volatile - newly entered positions are very likely to hit the stop loss and cost us. We prefer to get in, and the stock start to increase, and never looks back. Right now, there are few, if any, this kind of stocks as most stocks's moves are correlated with the indices' moves. On the other hand, there is no urgent need to liquidate your big winners either, as most likely, the bull market is still in place, and the Chinese indices are readying themselves for a move higher eventually. It is the big swing that makes the big money for you! Hold onto the winners; do not get out of them prematurelly.

    The Shanghai Composite is now trapped in a range. The long-term trend is up, the intermediate-term trend is sideways, the short-term trend is down. Be patient with it!



    Hong Kong

    The Hang Seng index is quite choppy, but it has issued a "buy" signal a few sessions ago as we detailed in a previous article. So far, so good.




    Europe

    Europe is printing money (1 trillion Euros) to try to get themselves out of the troubles. Printing money tends to result in inflation, which increases the price of everything, including stocks. So far, it seems to be working. Shown below is Germany's DAX index, yes, it sure looks good.



    USA

    Of all the major world indices, the US is the most confusing for now. US stocks have gone up a lot in the past 2 years. Now the indices are trapped in range-bound pattern. It will eventually resolve to either the upside or the downside. Right now, we'd better not be committed too much either way, as the direction now is not clear. We will take a wait and see approach and keep our positions in this market light.




    The Value of Market Corrections

    We love market corrections/consolidations. First, trading takes time and energy. During market corrections, the best approach is to wait, thus, we can take a break while the market is taking a break. Second and more importantly, during market correction, we can relatively easily identify which stocks are likely to surface as big winners when the marke correction is over. Indeed, 80% to 90% of successful patterns in individual stocks are created during general index correction.

    Chart patterns, or “bases,” are simply areas of price correction and consolidation after an earlier price advance. Most of them (80% to 90%) are created and formed as a result of corrections in the general market. The skill you need to learn in order to analyze these bases is how to diagnose whether the price and volume movements are normal or abnormal. Do they signal strength or weakness?

    Approximately 80% to 90% of price patterns are created during periods of market corrections, you should never get discouraged and give up on the stock market’s potential during intermediate-term sell-offs or short or prolonged bear markets. The stocks that form recongizable patterns will be the new leaders. Do not allow yourself to get discouraged and stop looking for winners just because the market is in a correction.

    Corrections, or price declines, in the general market can help you recognize new leaders—if you know what to look for. The more desirable growth stocks normally correct 1½ to 2½ times the general market averages. In other words, if the overall market comes down 10%, the better growth stocks will correct 15% to 25%. However, in a correction during a bull, or upward-trending, market, the growth stocks that decline the least (percentagewise) are usually your best selections. Those that drop the most are normally the weakest.

    Say the general market average suffers an intermediate-term correction of 10%, and three of your successful growth stocks come off 15%, 25%, and 35%. The two that are off only 15% or 25% are likely to be your best investments after they recover. A stock that slides 35% to 40% in a general market decline of 10% could be flashing a warning signal. In most cases, you should heed it.

    Once a general market decline is definitely over, the first stocks that
    bounce back to new price highs are almost always your authentic leaders. These chart breakouts continue week by week for about 13 weeks. The best ones usually come out in the first three or four weeks. This is the ideal period to buy stocks . . . you absolutely don’t want to miss it.

    The figure below shows how CBG, a real estate stock traded on the NYSE, copes with the general market correction (in the Spring of 2005). Subsequently, as the index turns around and goes up about 20%, CBG also turns around and goes up more than 100%. This is one of the ways we identify the best stocks, get in at the optimal point, and ride them to the end. Yes, we love market corrections.




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