Trading Market Corrections

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Before we can discuss the trading of 'market corrections' we must first be sure we are on the same page as to what 'market corrections' are.

The words 'market' and 'corrections' I would suspect are commonly understood individually, 'market' referring to the trading asset itself, such as a particular stock or futures product, and 'corrections' referring to some change to rectify some condition.

Put together, we are talking about the condition where a stock or futures asset has moved in a certain direction and then is 'pulled back' (ie. corrected) in the opposite direction.

To go deeper into the subject of trading market corrections, we should first set the stage as to what it is in reference to. As a market analyst, my focus will be on the 'trend' of the market, the predominant price direction for the most recent time period for the respective time frame being examined.

In order to insure this is not an exercise of subjectivity, I'm going to define what I believe objectively defines a trend and from that, we can objectively identify the market correction.

There are two trends aside from non-trending which are the 'bull trend' and the 'bear trend'. The bullish trend is one where prices are forming higher swing bottoms and mostly higher swing tops (there will be some outliers). The bearish trend would be forming lower swing tops and mostly lower swing bottoms.

To visualize this without graphical aid in this article, draw a line with an angle where the beginning left end is lower than the ending right end. From left to right this line is sloping up and we will call this the 'trend' line. Starting at the very left and above the trend line, draw another line (call this the price line) moving up away from the trend line but angled to the right by 30-45 degrees, then down to the trend line also angled right as before, and repeat this till you reach the end of the trend line.  

'Bull' means up, and 'bear' means down. As the price line is moving higher overall along this upward-angled trend line, we call this a bull trend. Every time the price line moved down to the line and then it would move up from there, that is a price swing bottom, and when it moved up away from the line and then turns around and moves back down again, that is a price swing top. You will note that in a bull trend, you end up with price swing bottoms that are forming higher than the previous swing bottoms. 

In a bear trend, simply imagine the trend line from left to right angled down and the price line moving down away from the trend line and then back up to the trend line as you continue across from left to right along the trend line. This pattern is clearly slanted down to the right, with each move up to the trend line making lower swing tops than the previous one. This is a bear trend pattern.

If the stock or futures prices are moving up overall in a bull trend, each move higher from the imaginary trend line is considered moving 'with' the trend. Each move back down towards the imaginary line is considered moving 'against' the trend. In a bear trend, moves down away from the imaginary trend line is moving 'with' the trend (a bear trend in this case), and each move back up again towards the imaginary line is moving 'against' the trend. 

These moves 'against' the trend are what we refer to as a 'market correction'. A market correction is a move opposite the predominant trend direction.

In the world of stock trading, most would reserve the term 'market correction' to only be a drop in prices where the market losses a certain percent of its gains. It is rarely associated with a rise in prices in a bear trend as stock traders are not as dual-directional as their futures trading brethren. For our discussion, a 'market correction' is synonymous with 'trend correction', meaning a move opposite of the current trend direction as defined by the trend description discussed earlier.

When the market is in a trend, whether it be a bull or bear trend, it is demonstrating what side of the trading party is in control. A bull trend is heavily weighted by more momentum to the upside, whereas a bear trend is heavily weighted by more momentum to the downside. It is usually not a good idea to trade against the momentum of the market.

In order to put the odds in your favor when placing a trade do not fight the predominant momentum direction of the market. So when it comes to market corrections, you don't want to trade the beginning of a market correction, but rather, what is likely the end of a market correction. This may sound really basic, like everything else in this article (on purpose due to not knowing the reader's knowledge starting point), but many traders make the mistake of buying new lower bottoms in bear trends and selling new higher tops in bull markets due to some indicator suggesting that the market is likely to turn. Don't fall for that trap! 

My job for the last 27 years has been forecasting these market tops and bottoms in advance. I've been analyzing and trading for many years prior to doing these forecasts for clients and am pretty good at it. And I can tell you with no uncertain terms that more often than not, knowing when a bottom is 'likely' in a bear trend does not equate to profits from buying it. Such a forecast is academic, but absolutely not a recommendation to buy against the trend. I've been so cocky at times and ignored my own experience and advice only to get burned by it time and time again. It doesn't pay to fight the momentum no matter how right or wrong you are in determining a bottom before it happens. 

Clients of my membership know what I call the Guidelines. It impresses upon the reader that using cycle turn dates (days where swings are expected to occur) should only be done in the direction of the trend and not against it. When a market is trending up, this means that it is part of a large bullish cycle that smaller cycles ride upon. If we discover the tops and bottoms of the smaller short-term cycle of a market, take the ones that are in the same direction as the larger cycle. The large cycle will almost always smash down the smaller opposing cycle for lack of a better description. Join them when they are allies, but stay out or choose the side of the larger move.

Trading market corrections when they are ending is the best entry point when entering an established trend. When the trend is bullish and let's say that by way of cycle analysis you know the probability is high for a swing top on day 5 and the following swing bottom on day 8, sit back and watch day 5 come and go, or if you are already long the market and don't want to stay in for the expected top and correction you can tighten stops, and wait for day 8 to arrive and confirm your expectation (at support) and upon such confirmation plan your entry to go with the trend.  Bear trends are no different. Don't enter the new bottoms but instead wait for the end of the rallies (corrections). It does not matter if you knew the bottom was going to happen when it did. It makes no difference at all. Write it down, "I will only trade in the direction of the established, clearly discerned trend!".

And that is how one should trade market corrections.

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Disclaimer: The analysis provided is not a recommendation or suggestion to buy or sell any commodity, index, or derivatives but for information purposes only. No trading advice is being offered or ...

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