At present, worldwide stock markets are bouncing around with no clear recovery in sight.  As soon as the media talks up the market, it just as quickly reverses, savaging traders.  How can you profit in a downward trending and volatile stock market?

As I have discussed in previous articles, the long term direction of global stock markets is downwards.  How can I tell this?  I ran a data filter over the closing prices.  This removed the random price movements, revealing the underlying trend.  Whilst the market appears to be going sideways, the longer term trend is actually downwards.

At the same time, the market is moving up and down around the downward trend (in other words, it is in a downward channel).  Since the long term trend is downwards, this means that the strongest trading direction is in going short.  This is not that different to having a bias towards going long when the market is booming.  At that time (now a distant memory), the odds were against you when you traded against the long term trend by going short.  Now the direction has changed.  You are more likely to profit by going short at the right point.

Since the market is currently fluctuating up and down around a downward trend, you can simply wait for the market to move upwards above the trend line, and then short it (while the long term trend is still downward).  Since it may be difficult to physically short stocks due to bans on short selling individual stocks in many countries, you can simply sell stock futures instead.

To select the point to sell at, determine the upper bounds of the channel, wait for the market to move to that point and begin to turn down.  Remember to set a stop loss to preserve your capital in case the market continues to move up.  Currently the market tends to move up one day, then drastically down the next, so look at clues to the trends towards the end of the day before taking a position.

Since the long term trend is downwards, it is important to resist the urge to try to pick a market bottom.  At this point, there is no evidence of a true turning point based on smoothing of the market data.

Tags: credit crunch, Stock Trading, uncertainty

This entry was posted on Tuesday, November 11th, 2008 at 12:09 pm and is filed under Market Commentary. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.