Lessons from the Pros

Stocks

What to Do About All-Time Market Highs?

While most investors are enjoying the returns they are receiving from this bullish market, everyone knows that it cannot last forever. The big question that many are asking is where is the top? Normally, prices would reverse and drop from levels of supply on the higher time frames. When the markets are trading at all time highs, however, there are no supply zones with which to identify the turning points.

Strategies for Trading All-time Highs

There are two possibilities for traders trying to determine when to sell bullish positions or enter shorts. The first is to wait until the bearish trend has been confirmed. The second is to use a technical tool called Fibonacci Extensions to project potential turning points for price.

There are definite advantages and drawbacks to each method. Waiting for the trend change to confirm itself offers a higher probability but will cause you to give up some of your profits from your longs and will cut your profits down a bit on your shorts. Using the Fibonacci tools will get you out of longs closer to the top and increase your profits on your shorts, but you run the risk of entering too soon and getting stopped out for small losses.

You must weigh the rewards and weaknesses of the techniques and decide for yourself which you will use. Neither is necessarily better than the other. You just need to be comfortable with what you select and stay committed to it.

Identifying a Trend Change

When evaluating the trend change, you must remember the definition of a trend and objectively read price action to ensure what you are seeing meets the criteria.  An uptrend is a series of higher lows in price followed by higher highs. A downtrend is lower highs followed by lower lows. Be careful not to look at every high and low. The trick is to be able to identify the impulse and corrective movements in the markets. The starts and ends of those movements are the highs and lows you want to use.

Looking at the trend change from 2007 into 2008’s bear market, prices were making higher lows and highs on the weekly chart until late 2007. Once price made a lower low in January 2008, the bearish trend was confirmed. At this point, long positions should have been exited and shorts entered.

Stock chart showing the change from a bullish to bearish trend after all time highs

From time to time, there may be false signals given from price. Looking back to the weekly chart of the tech bubble in 1999-2000, prices gave a false signal before truly reversing. This is one of the disadvantages of using the trend change method.

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Stock chart showing lower lows

Using Fibonacci Extensions

Fibonacci tools are based on a numerical sequence. There are certain ratios that hold importance and can be used to estimate potential turning points for price action. When we are making all-time highs, price is said to be impulsing higher. This impulse will follow a correction of a previous impulse. To predict where the impulse is likely to end, the Fibonacci Extension tool multiplies the preceding impulse by certain ratios and projects that measurement from the recent retracement point.

Fibonacci extension calculation formula

So, we can apply the Fibonacci Extension tool to the large time frame chart or the markets and estimate where we will see the trend reverse. Looking at the market highs in 1999 and 2007, the Fibonacci Extensions predicted the turning points for both peaks at a 61.8% extension.

Stock chart showing a fibonacci extensionHow to trade all time highs

So whichever strategy you select for timing the top of the markets, be sure to exercise risk management. There are losses possible in the markets but with the proper knowledge and skill, most can navigate them properly. The markets will eventually turn down; learn the skills you need to properly identify when and where they will do this.

I will be monitoring the broad markets and applying these techniques to anticipate the market turns just as I did in 2007 and 1999. To see more of my analysis, you can follow me on Twitter: @traderbdub. Of course, more training and skill building is available at your local Online Trading Academy center.

I want to wish everyone a happy holiday and prosperous new year! See you in 2020!


DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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