The Guacamole Dilemma: Dip Buyers Must Be Aware of Too Much Dip

So, when the markets drop 2-3%, which we have seen can happen within a week’s time – then is it right to buy that dip?  If you look at the chart below dating back a year the answer is a resounding YES.  But we are talking about drops/corrections in price and not time.  What makes many uncomfortable are the sharp drops in a few days that used to take a few weeks to occur.  We could blame that increase of speed on any ol’ reason – algorithmic traders, high frequency trading, hedgers, ETF’s, or just a more informed and reactionary investor/trader.  Gone are the days of buy and hold, which often turns into hope and pray mode!

spx 072614

Whatever the reason, we should look for patterns and trends that play out regularly, find confidence and go with the flow.  That gets us back to the dip question and how should we interpret what is a sufficient drop and whether it is appropriate to step in.  I have found over the past year plus these dips tend to be accompanied by very sharp changes in sentiment.  We’ll see a VIX spike as we had on July 17 and reversal – one of many that has occurred since 2012.  The McClellan Oscillator will show an extreme reading, with the NASDAQ and NYSE oscillators ticking down under -100 (very oversold).  Put/calls often zoom past 1 in these instances and the the polls show fewer bulls, traders getting more fearful (such as the AAII and II have lately).  When these all line up congruently I have found the best odds are buying that dip.

But each dip could be the last one, faking everyone out – right?  Sure, but is that likely with so much liquidity in this market, low interest rates and strong corporate profits – not to mention a very dovish Fed that will continue to provide accommodation?  I side with recent history.

Money moves very FAST in this market and if you’re not positioned right you can be trampled.  Discipline trumps conviction in most cases and we must be willing to take profits and losses and move on.  As option traders, we do not have the luxury of time if we are buyers.  With low volatility in this market it means options are priced cheap, a great condition if the trend continues.  But market trends are not necessarily stock trends.  For instance, the markets were hammered on Friday yet some stocks performed well.  While we know Amazon was clobbered down 10%, Baidu was up nearly 13%.   Freeport McMoran was up 1%, Apple was up .6% but Netflix was down 1%.  My point is this:  We continue to live in a non-correlated market, a stockpicker’s delight.

The best friend of a stockpicker is usually the chart and technical’s, which gets us back to the dip dilemma.  Do we trust each dip to buy, or is the next dip the ‘sucker move’, the one that takes stocks down for that massive 10-20% correction that EVERYONE expects?   You can sit around and wait for that, and much like a broken clock you’ll be right some day – but how much time have you wasted in waiting for it?  Let the market tell you what to do.  Currently, the market is consolidating recent gains (heck, from Feb 1-June 30 the SPX was up 12.7% – entitled to a break?).  In July the SPX is up a scant amount, the Dow Industrials and NASDAQ are up solid while the Russell 2K is down an ugly 5%.  What’s to come for August and September?  I won’t guess the move, but certainly buying dips has been the right play – it will continue to be, until it’s not.  At some point the pattern changes, and if that happens we may not have something left for our chips to dip.

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Bob Lang

explosiveoptions.net

Founder and Portfolio Manager — Bob has been trading options for himself and private clients for more than ten years. He uses a unique combination of technical indicators to find the best trending stocks that exhibit enormous velocity and ferocious movement. He often gets in front of these moves before they happen. Patience is…