Reader Q&A: How Did I get Caught On The Wrong Side of the Trend?

Reader Ian got caught on the wrong side of the market, when a downside breakout seemed to have occurred on October 3^rd. Unfortunately for Ian, it was only an intraday drop below the trading range, which turned into a trend reversal.

Here’s part of what he had to say:

Do you know why the market didn’t break down and crash when we broke down through the bottom of the trading range last week? (October 3rd) 

We did so very convincingly, so I went short in a big way and got creamed.  I thought that once the trading range was broken, one way or the other, that the market would then run in that same direction.  Additionally, I thought that when a trading range broke, it normally broke in the previous direction of the market, which was down. What went wrong?

Yes, you are correct with all of your assumptions. Unfortunately, markets don’t always oblige and you simply experienced a whip-saw signal.

You might have been a little bit early in setting up your short position, since a true breakout is usually determined by whether the market, in this case the S&P 500, actually “closes” below the trading range or not. This did not happen; we only peeked below it on an intraday basis, before a trend reversal set in and pushed in the index back to the upper end of the range during the subsequent 2 weeks.

Breakouts are not a guarantee that follow through momentum will develop, and a new market direction will be established. It happens most of the time but you can count on it 100% of the time when you are on the sidelines and not participating. That’s been my experience.

This is why I have been harping on the use of trailing sell stops no matter whether you are going long or short. It’s imperative to control downside risk at all times; if you followed my 7% exit strategy, that’s the loss on the invested position you should have realized.