One Man’s Bear Flag is Another’s V

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MARKET WRAP UP 02/28/11

When analyzing the price action and volume pattern of the daily chart of the IYT above, the easy answer is to declare this an obviously bearish chart and eagerly put on a short position. After all, we have a recent pattern of price breaking down on heavy, increasing volume last week, only to bounce back on declining volume and stall out today at the 20 and 50 day moving average convergence. Indeed, this pattern is commonly referred to as a “bear flag,” with the expectation of another sharp leg down coming after the relief bounce rolls over.

The problem with aggressively acting on that type of analysis since March of 2009 has been that we remain in a cyclical bull market, with various “V-shaped” recoveries to fresh highs in the face of charts like the one of the ETF for the Dow Jones Transportation Average above (recall the fall of 2009, in particular). Beyond the IYT, below are few more examples of the “obvious” short setups, that may end up being traps for bears to fall into after all.

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Adapting to a market that refuses to stay down even with troubling signs under the surface often involves loosening up one’s trading style and discipline. Chart patterns that were not attractive long candidates last fall will now have to suffice, as the broad indices flash green and compel traders to chase. While aggressively getting out in front of the tape and putting on heavy shorts involves the risk of being flattened like a pancake (as the bears were in the fall of 2009 with those V-shaped bounces in lieu of bear flags) it does not necessarily follow from that argument that being an aggressive bull is correct either. Lightly participating on the long side until we see firmer charts is likely the best strategy for both protecting and carefully growing capital here.

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