This strategy is the opposite of buying dips, and applies in a bear market. It involves taking a short position, selling on temporary strength, an upward retracement or consolidation, in an otherwise downtrending market. Here are the steps involved —
- establish that the market is going down
- check that the sector is going down
- make sure that the particular financial security is going down
As with the strategy for buying dips, at this stage you would put the security on a watchlist, following its path downwards. If it was trending strongly downwards, you might consider using the next strategy, selling relative weakness, instead. Otherwise you wait for the downtrend to falter, and to become a minor rally, as follows –
- wait for a short-term rally in price
- wait for the short-term rally to end
- calculate trade size and stoploss
- enter trade short
- exit trade if failed or on profit
We would again look at the moving averages or by inspection determine that there was an established downtrend, both in the market as a whole, in the sector, and in the security. The signal that there is a short-term rally would be that the price was higher than previous few sessions, or that the RSI has been overbought for three sessions.
As previously, you should make sure that this trade has a favourable risk/reward ratio. Your risk is established from the stoploss position which you have already calculated, and the rewards depends on your view of where the price may go in the short term – either to a previous support level, or to fall by a certain amount, or to a channel line, or to a Bollinger Band. There are many different ways that have been detailed previously in the technical analysis section, and you should try different ones and see which works best with the financial security you’re trading.
The rally can be considered finished when the price falls below the previous lows. The protective stop would be above the previous highs, and the exit would be on a trailing stop or if a moving average turns up, signaling the end of the downtrend.
