After sucking wind in August and September, stocks rallied an epic 8% in October.
There’s a term for this seemingly odd experience. It’s called a whipsaw, which basically describes when something alternrnates rapidly in contrasting directions.
In market-speak, a whipsaw is when the dominant trend turnrns from bullish to bearish (as it did in August/September)… and then, very quickly, back to bullish (as it did in October).
The sudden reversals leave adaptive strategies (i.e. those that adjust, long and short, depending on the trend) temporarily on the wrong side of the trend. It’s certainly an unpleasant experience, but it’s largely an unavoidable “cost of doing business” as a trend-following investor.
Interestingly though, many of these bullish-to-bearish-to-bullish whipsaws have occurred before significant declines.
In 2001, after the trend turnrned from bullish to bearish, stocks rallied 20% in 32 days… then stocks fell 29% over the next four months.
In 2007, after the trend turnrned bearish, stocks rallied 12% in 40 days… then they fell 23% over the next three months.
In 2008, after the tide turnrned bearish again, stocks rallied 15% in 44 days… then they plummeted 60% over the next nine months.
History shows that it pays to stay bearish throughout these whipsaws, bearing the pain of the short-lived rallies, which have typically lasted between one-and-a-half and two months.
Of course, there are also historical examples that show a different patternrn – one in which bullish trends prevail. I shared the details of these with my Cycle 9 Alert subscribers yesterday.
My point is that a sharp, one- to two-month rally, following a newly-emerged bearish trend, is common.
So even though bearish stock positions have taken heat over the last five or so weeks, there’s still a good chance the rally will peter out and be followed by a tumble. That’s why, for now, we’re staying in well-positioned bearish and hedge plays only in our Boom & Bust portfolio.
Adam O’Dell, CMT
Chief Investment Strategist, Dent Research