Nobody can always catch the market’s tops and bottoms. Sometimes you will miss the trade because you waited too long. E.g. You wanted to wait until RSI fell to 20 before buying. The market fell, RSI fell to 23, and then the market reversed upwards. You missed the trade, and you think that the market’s bottom is already in.
Here’s how you can chase the market’s reversal after you’ve already missed the trade.
Method 1: Go all in
Go all in the instant you think you missed the trade.
E.g. if the market was falling and is now rallying, just go 100% long right now since you think the market’s bottom was already in. This means that you would go all in after the stock market bottomed in March 2009.
This is the simplest way to chase the market’s reversal.
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Advantage: The advantage for this method is obvious: if the market’s bottom is indeed in, you don’t waste any time in chasing the market. The longer you wait the worse of an entry price you’ll get. Waiting is an opportunity cost.
Disadvantage: This method also has an obvious drawback. What if that wasn’t the market’s real reversal. What if that was just a short term countertrend move? You would’ve bought at a much higher price than you originally wanted to if the market falls back to your original price target.
E.g. You want to go long. You expected the market to fall 15 % before making a medium term bottom. The market fell 10% and then it bounced 5%. You went long AFTER the market bounced 5%. But you were wrong: the market’s bottom wasn’t in. The market fell another 10% before bottoming. As you can see, you bought into a fake rally at a high price.
That’s why I don’t prefer this method for chasing the market.
Method 2: Don’t chase the reversal at all
Some traders choose this method. It’s the “it’s ok if I miss the trade” mentality. These traders think that there’s no point in chasing a trade because there will always be another trade. I disagree.
- The “it’s ok if I miss the trade” mentality is only suitable for short term traders who place A LOT of trades. I.e. there’s no point in chasing a trade if you put on dozens of trades every year. But if you only place a few trades each year, your missing a trade will be detrimental to your trading performance. A missed trade is an opportunity cost.
- Missing a trade can be detrimental to your trading psychology and cause you to chase the market AT THE EXACT TOP.
E.g. you originally wanted to be long because you expected the market to rally 20%. You missed the trade. The market rallies 40%, and you think “holy cow, this is the start of a much bigger rally”. You buy after the market has rallied 40%. That happens to be the market’s top, and you bought AFTER it rallied 40%. The market then promptly falls.
Advantage: You don’t chase the market at a terrible price if the market’s real reversal isn’t in. E.g. You originally expected the market to fall 20%. The market falls 10% and then bounces 5%. But you don’t go long and chase the trade. The market then falls 15% to your original target price. You buy at -20%, the market’s exact bottom.
Method 3: my preferred method
This is a combination of Method 1 and 2. It captures some of the advantages of both strategies.
Use part of your intended position to chase the market right now and put the other part in cash. Go all in if the market moves back to your original price target. Don’t chase the market if the market doesn’t move back to your original price target.
E.g. You wanted to go 100% long $SPY. The market fell, but it didn’t fall to your price target before reversing upwards. Go 50% long right now, even though the market has already bounced. Go 100% long if the market falls again and hits your original price target. Stay 50% long and 50% cash if the market just keeps rallying. Don’t chase the market with the 50% cash.
This method will soothe your trading psychology. Thanks to this method you will not be afraid of missing out on trades because you already have some position. At the same time you will not be afraid of being caught by dead cat bounces because you didn’t go all in. You can buy if the market falls again, thereby lowering your average price and avoiding a big short-term loss.
All 3 of these methods have obvious advantages and disadvantages. Method 3 provides the best balance between fear of missing out on a very profitable trade and fear of being caught by a big short term loss.