I Spy a Bear Market Rally Brewing…

This week the Nasdaq hit bear market territory, joining multiple key sectors already struggling. 

The sectors and industry groups (as noted by moves in key exchange-traded funds (ETFs) that entered bear territory before the Nasdaq) include: 

  • Prime Cyber Security ETF (HACK), 
  • First Trust Cloud Computing ETF (SKYY), 
  • SPDR S&P Homebuilders ETF (XHB), 
  • VanEck Vectors Semiconductor ETF (SMH), 
  • Communication Services Select Sector SPDR ETF (XLC)
  • …and more!

The Technology Select Sector SPDR ETF (XLK) is teetering on the brink of a bear market as well. By the looks of Microsoft (MSFT) and Alphabet (GOOGL) trading below key resistance at the 200 simple moving averages (SMA) on the daily charts, it’s going to take quite a bit of a catalyst for the technology sector to recover. Also, Apple (AAPL) remains the core component of the Nasdaq, and XLK is holding up above key support zones at the 100 SMA and the 200 SMA on the daily charts.

The problem is, Apple can’t hold the weight of the Nasdaq on its own.

So goes Apple, so (continues to go) the market. Check out this daily chart of Apple below:

Above is a screenshot of AAPL on the daily chart on March 9. As you can see, it has shifted into a downtrend after making the high at $182.94 – when it hit the $3 trillion valuation. The TrendStrength Turbo candles shifted from green to yellow, and then red. Price shifted from being above the moving averages, to below. Instead of holding support, the price is stuck below resistance. The last remaining area of support is between $150-$155, where the 200 SMA and Fibonacci support zones lie. 

As of right now, Apple is one of the only core technology stocks that is holding up decently well. But, traders beware – Apple is only about ~$11 (a break of $150) from sending the Nasdaq to new lows. This would also send XLK into bear market territory.

Keep an eye on this canary in the coal mine – where Apple goes, it’ll likely lead the market, unless it can get above $170 and stay there. It remains in a downtrend along with the rest of technology.

So, should you focus solely on shorting? 

The news weighs heavily on the market and the path of least resistance remains to the downside – meaning most stocks in weak sectors listed above can be shorted on rallies. Traders must be aware of this key phenomenon that occurs during bear markets – “bear market rallies.”

How do bear market rallies set up?

They almost always happen on a day when the index futures gap up overnight, after a day (or several days) of consistent selling. Generally, a news catalyst will hit overnight, causing a run-up in price that causes a gap higher. When these sets of factors occur at the same time, the stage is set for a rip-roaring rally higher – bear market rally. 

What you should look for:

  1. The indexes are normally at, or near, most recent lows
  2. Fear and sentiment is generally very weak
  3. An overnight, news-related catalyst appears. This can be good news or simply the absence of bad news!
  4. The catalyst results in an overnight gap in the index futures. The gap can be anywhere between 1% or more, but the higher the percentage, the bigger the catalyst. 
  5. The put/call ratio demonstrates that traders are lopsided to the short side, meaning far more traders are short rather than long.
  6. Short interest in the indexes is 10% or higher (applies to individual stocks). Here is a link to short interest data in the QQQ:  check out my Twitter post here
  7. High $ticks appear at market open (demonstration of major buying), along with a rising volume spread (difference between the volume up and volume down), a falling UXVY (a measure of volatility), a falling put/call ratio, and higher price action in the indexes. These factors indicate short-covering.

These factors can then lead to a short squeeze.

What is a Short Squeeze?

When too many traders are short an overnight gap can send them covering – all at the same time. Combined with buying, this sends the market rocketing higher. This action, in turn, can kick off a larger bear market rally.

Check out the key factors (image below) I use to determine if a bear market rally is kicking off:

I use this grid to read what we call the “market internals” to determine if a bear market rally will kick off, precipitated by a short squeeze. These short squeezes – a situation in which too many traders are short and they begin covering their shorts – can cause FOMO (fear of missing out). FOMO causes buyers to come out of the woodwork. These traders start rapidly buying (as evidenced in market internals) causing even more short sellers to cover, which continues sending prices higher.

This is what kicks off a bear market rally!

Want to learn more about my market internals grid and pick up this freebie for thinkorswim®? Click here!

The stage is set – now what?

A bear market rally can’t start without some momentum. The stage can be set, but the follow-through may not happen. If short-sellers don’t cover, and if buyers don’t get enticed to jump into the rink, this setup will merely roll over and die and continue in its downtrend. 

But, if this bear market rally starts running, my favorite actions to take are:

  • Identify the first tickers to rally. Find Phoenix stocks and trade them up into resistance (don’t confuse this with a bottom or a turnaround!)
  • Identify the weakest links – the canaries in the coal mine (as mentioned in the sectors above). As these weak links rally into resistance, I can short them at more opportune levels. 

The Bottom Line

Bear market rallies come on quickly, providing short-term trading opportunities – if you know where to look. These rallies can also trick investors into getting over-enthusiastic about buying (FOMO effect).

Remember, in this kind of market, fading moves rather than going with momentum for long periods is generally going to function the best. The days of putting on swing trades and following a nice, gentle trend are long gone. We must adapt to the times! 

Want to learn more?

Join me in Stacked Profits Mastery where I update members daily on my take on the market internals, key tickers I’m watching, and what I’m trading, and to trade the next bear market rally.

Up Next...

Using Butterflies to Short Stocks

Market Volatility Market volatility has picked up, meaning there are more downside opportunities than before. When the market starts pulling back, I always try to quantify if it’s a normal “buy the dip” opportunity or if it’s a little bit deeper of a move that means it’s time to short some stocks. Identifying Bearish Alignment … Read more

Read More

Critical Stock Market Red Flags

With earnings season just beginning, we are entering the most risky time frame for the stock market. Netflix earnings week is already kicking off with a bang. The Nasdaq sold off yesterday, ending the day down -1.67%, with critical stocks like Tesla down -5.59%, Microsoft down -1.97%, and Meta down -2.28%. This occurred after escalating … Read more

Read More

Using Conservative Sell Signals To Exit

Hey traders! In this week’s trade review video, I discuss the conservative signals I had that caused me to take a cautious profit on Amazon. Sometimes I’ll take conservative profits, especially in a case like before CPI data when a news-related event is upcoming. Now, of course, if you take conservative profits, you cannot capitalize … Read more

Read More

Subscribe Today!

Want my up-to-date analysis, setups, top trading tips, and more? Be a Five Star trader, and join my free newsletter today!

Sign Up Now