V-Shaped Recoveries Can Be Spooky–but Profitable

October is known for being a volatile period in the financial markets, and this year’s Halloween month turned downright spooky for many stocks.

And we all know that spooky market downturns always bring out the shiny suits. You know them . . . they appear on financial television networks and fill our screens with their “What? Me worry?” jocularity.

“We love this move down,” they insist, leaning into the camera and flashing their California-white smiles. “Heck, yeah, buy now. We think this is a great place to buy!”

Since I’m never quite sure where this is, and since I’ve been in the market long enough to have experienced spooky bear markets that dive lower than you think they can or will, I don’t trade my hard-earned capital for stocks in downtrending markets  without knowing what I’m going to do if this morphs into a cliff-fall.

As well, at this point in my life, I refuse to ride a bear market down to goodness-knows-where. So with that in mind, in dicey markets, I take great care in entering new stock positions. (Actually, taking “great care” when buying stocks is a good idea all the time.)

When I look at a stock that has fallen from grace and that I am considering buying, I first make sure that it is either a Dow component, or a leader in the S&P 500, or a company with good fundamentals. In other words, I want a stock that has fallen due to the market downturn—not a stock that has fallen primarily because of its own deteriorating fundamentals. High-quality stocks tend to rally nicely when the market heals from a barrage of bears. Low-quality stocks may not be so fortunate.

Next, I go to my charts. And I ask three questions:  1) What if the short-term consolidation I now see on my target’s daily chart is not the bottom of the current down-move? At what price will I exit?  2)  Knowing the general mood and manner of the market, will my stock potentially have enough enthusiastic buyers and institutional support to overcome and absorb the overhead supply?  3) If my stock is able to rally off of its current low price, and if it grows legs, how do I plan to manage my risk?

Recently, I targeted Deere & Co. (DE). While I realize that Deere has skated south—on and off—for the second half of this year, the machinery stock really “got ugly” in the market’s recent September-October tumble.

When we look at the daily chart of Deere below, we note that it touched a May high of ~$95. The recent October low was at ~$79—a 20% drop.

Deere & Co. (DE) Daily Chart

 

DE Daily Chart

Created with TradeStation. © Trade Station Technologies, Inc.  All rights reserved.

After quickly checking fundamentals, noting strong volume and a few other criteria (we’ll talk about them later), I took on a small position of Deere on the bounce (highlighted) at $81.50. I placed a protective stop at $80, and then trailed under price as it moved higher, making a high of $86.  When Deere pulls back–which it will—market conditions will tell me to take all or part of my profits, or perhaps even add to my position. And I will still have my protective stop in place as insurance.

Remember, no one knows when the bottom price of a stock, index, or any other financial asset is in place, until it is confirmed by further price action to the upside.

V-shaped recoveries are not for the faint of heart, and they are not for market novices.  In fact, they can be downright spooky.  Still, with the right skill-set, they can be played successfully.

Until next time, keep green on your screen,

Toni Turner