S&P 500: Why Tuesday's Dip Under 4,100 Was Encouraging

S&P 500 Index, Daily Chart

The tumbled at Tuesday’s open, easily undercutting 4,100 support. But within 10 minutes, the storm passed and it was all uphill from there. By the close, the morning’s 1% loss turned into a very respectable 1% gain.

If trading were easy, everyone would be rich. Sometimes the market needs to convince us we’re wrong moments before proving us right. It appears that’s all Tuesday’s momentary violation of 4,100 was, a little head fake before resuming May’s rebound.

The encouraging thing about the dip under support is it didn’t find many sellers. In fact, within minutes supply dried up and prices bounced. While I’d love to see the index charge higher every single day, the market doesn’t work that way. Sometimes we need to go through a few stepbacks before we can start the next leg higher.

As I wrote , I pulled the plug on a portion of my position Monday afternoon when early strength fizzled and the index closed at the intraday lows. While that weakness didn’t cross my stops, it was enough of a warning flag to convince me to take some risk off the table.

That caution appeared to be the right call when the index tumbled Tuesday morning. In fact, that gap jumped over some of my stops. But an opening gap is the single exception to my stop loss rule. Rather than reflexively sell the open, I give the market 15ish minutes to find its footing because more often than not, opening gaps bounce. Since I already took the biggest lump at the open, holding for a few more minutes to see if prices bounce doesn’t add a lot to my risk. If the selling continues, I get out a few points lower. If prices bounce, the early lows become my new stops and I keep holding.

As luck would have it, Tuesday’s early weakness bounced and I didn’t have to sell. And more impressively, when the index retook 4,100, I started adding back in what I sold the previous afternoon.

The market has a nasty habit of knowing exactly where our stops are and it loves violating them. But the best part about being a nimble trader is we can both stay safe and still be in a position to profit from the upside. As easy as buying back in is, there is no reason to stubbornly hold a dip. For as many times as being stubborn works, there are a dozen times it bites us in the ass. I would much rather sell and buy back in hours later than I would watch the losses pile up as I keep waiting for a bounce that never comes.

That sounds like a lot of effort for what amounted to an unnecessary trade, but protection against larger losses doesn’t come free. Just because holding worked this time doesn’t mean it will work next time. (Just ask all the people waiting for the market to bounce back above 4,500.)

Now that the index is back above 4,150, I can spread my stops across the lower 4,100s. If we retest support again this week, there is no coming back from that and lower prices are ahead. But since four tests of 4,100 support over the last five trading sessions failed to break the dam, it appears we are standing on solid ground and a continuation to 4,300 is the most likely outcome.

Keep holding for higher prices and continue lifting our trailing stops.