Last week was a tough week for investors…
According to The Wall Street Journal (WSJ), the Nasdaq’s 5.8% drop was its worst week since January 2022.
And the S&P 500 only fared slightly better…
Despite a supposed rotation into defensive stocks, the S&P 500 fell 4.2% over the same time.
It all fed into the narrative about September being a tough month for stocks.
As the WSJ further noted:
Going back to 1928, the S&P 500 has declined an average 1.2% in September, the weakest month of the year for stocks.
That type of statistic might scare plenty of investors off. But it doesn’t mean you should avoid stocks this month altogether.
You just need to know how to trade them…
Based on Emotion
One of the key mistakes investors make is having an “all-in” or “all-out” approach…
They buy into the market when there’s lots of positive news around.
And they bail out when that news turns negative.
The problem is that these decisions are based on emotions. I learned from painful experience that is an extremely low-probability way to trade.
Plus, the news is historical… Yet markets always look to the future.
So trading off the news puts you behind the curve. It means you could miss out on plenty of profitable trading opportunities.
That’s why I watch technical indicators on the chart instead.
They let me know when a stock could be due for a bounce… even when the news is all negative.
Watching Momentum
One way I look for trading opportunities is by monitoring momentum…
Typically, folks use momentum to identify a trending stock. So, for example, if buying momentum is increasing, they’ll see that as a bullish signal and a reason to buy the underlying stock.
Yet I use momentum differently…
I look for a momentum reversal as a potential entry point for a mean reversion trade.
That is, I place a trade when a stock has overshot in one direction and is likely to snap back the other way.
To see what I mean, consider the chart of the Nasdaq-tracking Invesco QQQ Trust Series 1 (QQQ) below. The Relative Strength Index (RSI) in the lower half of the chart shows buying momentum.
Invesco QQQ Trust Series 1 (QQQ)
Source: e-Signal
As you can see, QQQ’s sharp fall in July coincided with the RSI inverting and tracking lower.
The inversion occurred above the upper gray dashed line – a level that represents overbought territory.
The RSI fell and then rebounded off its August low. But around mid-August, it rolled over and has been tracking lower again.
At the same time, you can see QQQ making a lower high in mid-August and tracking lower.
In these examples, declining momentum (RSI) led to QQQ falling.
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Forming a ‘V’
Given the recent action, I want to concentrate on the bottom half of the chart (orange circles) today…
That’s where the RSI rebounded higher from oversold territory (lower gray dashed line).
As you can see, when the RSI formed a ‘V’ and bounced off that oversold level, QQQ bounced as well.
That happened in October last year and April and August this year…
The chart shows that the RSI could soon be tracking in the same territory (red arrow). That could set up QQQ for a potential bounce…
Take another look:
Invesco QQQ Trust Series 1 (QQQ)
Source: e-Signal
The key thing is to be patient and wait for a defined ‘V’ before considering opening a long trade. We want to see the RSI turn and start to rally.
Of course, like anything in the markets, there are no guarantees…
The RSI’s initial bounce could fade, leading to QQQ making another leg lower.
But as the orange circles show, waiting for the right trade setup puts the odds dramatically in your favor.
So don’t get caught up in negative news… Instead, watch the charts.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict