Happy New Year!

So, we have spent some time talking about the bullish patterns and that is good for the markets we have seen in recent vintage, however, what happens when we get a market that is more like 2008 or 2009?  Does that mean we just stop trading and wait for the Bears to get tired out?  That is what investors do but not what traders do!  As we talked about last week we don’t want to have to sit around and wait for the market to go in one direction.  We learn the four pillars of investing so that we can profit from a market that goes up, down or sideways!  After going through the setup and the process of the bullish patterns we should now be able to appreciate the Bullish Retracement and the Bullish Breakout patterns and the setup that is required to ensure that we have the best odds of the trade going in our favor.  We can go into the other side of the market, the Bearish side of the markets.  We have patterns that we can look for in both up and down markets and that gives traders unlimited opportunities in the markets.

This week we are going to go through the Bearish Retracement.  You can imagine that the setup and the things we look for are very similar and that is correct, however, bear markets behave differently than bull markets and we need to take that into consideration when trading the bearish side of the markets.  So, before we get into the bearish patterns lets have a discussion about how bears are different than the bulls.

Bull markets can be characterized as slower moving, possibly more orderly and typically longer in time frame than its counterpart the bears.  Take a look at the chart below, it is a chart of the SPY for the last 20 years on a weekly basis.  You can see that typically bull markets tend to stretch out longer and move upwards in a gradual type fashion.  I have highlighted the last couple of bull markets in blue and I have marked the last couple of bear markets in red.  You can see that the ideas mentioned above play out pretty well with the visual.  You may be asking what has this got to do with the bearish patterns we are looking for?  Well, the obvious answer is one would tend to see more of these patterns during a bear market and this is true but we can also find these patterns during a bull market as well we just need to adjust our thinking ever so slightly when it comes to the two different market types.  The reason for the adjustment in thinking is that the markets move at different speeds and we need to react differently to each market condition.  Another nugget of wisdom from the trading community goes a little something like this…”Bulls take the stairs and Bears take the elevator.”  The chart below shows this to be true.  The difference between a bull market and a bear market is that the bear market tends to have a lot more volatility to it.  This means that the moves come faster and can be bigger.  This means that if we find a Bearish Retracement in a bear market we need to be ready to take profits or move our stops at our target price faster because it will most likely hit that target quicker and can have a violent reversal, we need to be prepared for that reality.  We also need to have our targets and stops ready in a bull market it just typically moves slower and we have a little more forgiveness because of the lessened volatility.

This brings us to the Bearish Retracement.  We require certain criteria to ensure that this is a higher probability trade.  This criterion is not much different than the Bull Retracement other than that we are going in the opposite direction.   The most obvious of the criteria is that we need a downtrend as defined by the name.  A downtrend is defined as a series of lower highs and lower lows.  After we have an established downtrend we want to make sure that the downtrend is strengthening.  By that, we want to see the drop on each successive drop to be bigger than the one before, ideally.  This extra strength gives us a very good indication that another drop will come after the next retracement or temporary up move.  That brings us to the third thing we need and that is a corrective retracement or it could be called a minor up move.  This move should be at least three candles in length but should also be slowing into a reversal type setup.  That brings us to the next thing we look for and that is a reversal type candle.   We discussed that in the Bullish Retracement, that would be the doji, the hammer, and the bearish engulfing candle.  I have put examples of these types of candles in the pictures below.  When we get one of these types of candles that gives us a signal that the next down move is on deck.  If we get this candle at a former support/resistance level then it is even more powerful for a potential reversal.  Lastly, we are looking for the volume to be decreasing on the retracement and we expect the volume to pick up as the reversal takes place.  If we can put these criteria together then there is a good chance that we will get the Bear Retracement and we should get a decent move to the downside in which to make some profits.

Below is an example of a Bearish Retracement candidate. In the example below, you can see that we are definitely in a downtrend.  We are making a series of lower highs and lower lows.  With this example, one might expect that this equity could head back down towards the bottom of the channel and this could happen or it could head back up towards the top of the channel and this is when a Bearish Retracement setup could happen. In this example, we would be looking for at least three days of upward movement and then the reversal candle and the volume to play along as a potential candidate for a bearish retracement. If this example reached the top of the channel with slowing momentum then it would give us a better chance of working out in the desired direction.  Remember that these patterns can be found in bullish and bearish markets but the bearish markets are much more volatile and tend to have faster and wider movements.

That is the bearish retracement in a nutshell.  Next week we will finish up the four major patterns with the Bearish Breakdown.  After we have our major patterns down we will start to bring our technical picture into view and refine our technical skills so that we can master our entries and exits.  We will next discuss triggers and stops and how we use them to make sure that even if our higher probability trades don’t work out that we protect our capital.