Earlier this year, global stocks sold-off as traders worried about the impact of the coronavirus pandemic. As more countries moved into a lockdown, market participants worried about profitability and the potential of the biggest recession in the world.
Sadly, such sell-offs happen in individual stocks every day. For example, recently, Netflix stock dropped after the firm announced weak earnings (as shown in the following pic). In this report, we will look at several profitable trading strategies during a market sell-off.
Waiting for bearish consolidation
A strategy that has proven relatively profitable is waiting for a bearish consolidation after a sell-off. Ideally, when the price of a financial asset declines sharply, it reaches a point where traders start to question the strength of the sell-off.
In this period, some buyers start coming back while some sellers start exiting their trades. In most cases, this period usually has a psychological importance.
Take advantage of the consolidation
For example, it can be the point where it retraces 38.2% or 52% Fibonacci. It could also be the lowest level in a week or month. Therefore, since you will often miss the initial sell-off, you can take advantage of this consolidation.
Watch for the next decline
In the past, we have talked about the bearish flag and bearish pennant pattern. A flag resembles a parallel channel while a pennant looks like a triangle pattern. Once you spot the pattern, you can place your short trade and take advantage of the next phase of the decline.
A good example of this is shown in the Netflix chart below. As you can see, the price sold-off after it missed on the estimated user growth. As of this writing, the stock is in a bearish consolidation process as traders question the next movement.
Ultimately, there are higher chances that it will break-out lower.
Dollar cost averaging
Dollar cost averaging is a trading strategy that is often recommended for long-term traders. The idea is relatively simple. Assume that you are increasingly bullish on the stock of a company that is trading at $100 and you have $10,000 to trade. In this case, you can easily buy 100 shares.
Alternatively, you can divide the funds into 4. In the first part, you can buy 25 shares when the stock is trading at $100. If the stock drops to $98, you can spend the rest $2,500 to buy 25.5 shares. If it drops to $95, you can buy additional 26.3. And, finally, if it drops to $92, you can buy $27 shares. In total, you now have 103 shares. As such, if the stock finally rises to $110, you will make a bigger profit.
As a day trader, using this approach is relatively difficult. Indeed, it can be damaging to your account because you will be adding to your losses. Therefore, we recommend that you use it primarily for your long-term accounts.
Using support levels
Another approach of trading during a market sell-off is to identify key support levels. The idea is to keep shorting once bears manage to push the price below a certain support level. Fortunately, there are several approaches of drawing these levels.
For example, you can use the Fibonacci retracement level. In this case, if the price moves below the 50% retracement, you can be certain that bears will continue pushing it to the 61.8% retracement. Similarly, if it moves below the 61.8% level, you can short the asset because it will increase the possibility that it will continue falling.
Another way of using support levels is to use pivot points. These are points that are drawn by considering the open, high, low, and closing prices (here we talk about OHLC Charts, if you are interested). Examples of these points are the classical, Woodie, Fibonacci, and camarilla.
The idea is that you should continue selling once bears overpower the support levels. Examples of the Fibonacci and classical pivot points are shown below.
A market sell-off is usually a difficult time for market participants, especially long-term bulls, who suffer losses. However, it is an opportune time for short-term traders, who can make money by both shorting the asset and by buy when the price bottoms.
External Useful Resources
- The Only 2 Moves to Make If the Stock Market Sell-Off Continues – TheFool