When markets rally, it's usually a slow and deliberate climb on the way up. Just like taking the stairs walking up in a high-rise building. When markets sell off, the drop is usually fast and steep, just like taking the elevator on the way down.
Let's look at a daily chart of the US 500 Index.
Look at the difference between the length of each green daily candlestick on the way up. You will quickly notice that they are much smaller than the red candlesticks on the way down.
It's also important to note the relationship of the markets in relationship to the "T-Line" (8 EMA), which is plotted in purple. On an uptrend, the market travels above the T-Line. On a downtrend, the market travels below the T-Line.
Finally, Stochastics (set at 12,3,3) can help you identify when markets are overbought or oversold, signaling a potential reversal. When it's above the 80 line, a move to the downside is imminent. If it's below the 20 line, a rally back to the upside is also imminent.
Election Week - What's happening?
The US Equity Indices (Dow, Nasdaq, S&P 500, Russell 2000) all broke sharply below the T-Line which suggested that strong selling pressure was in progress.
You can argue all day long as to why that is happening. Covid-19 surge, Stimulus deal delayed, Election-Day jitters prompting a wave of profit taking, or maybe a combination of all. To me, none of that matters. The charts graphically depict investor reaction to the events of the day.
How to trade this?
For my part, I have been extremely cautious over the past 2 weeks. While I trust the market's relationship with the T-Line, I'm also aware that markets can reverse sharply on a tweet.
So, I have consciously made the decision to reduce my exposure to risk through the General Election.
With Nadex, there are a few ways to do that:
- I can reduce the number of contracts I trade, thus limiting the amount of capital exposed to risk.
- I can adjust my risk per trade, risking less per contract for a greater reward.
- I can do both of the above
Stocks take the elevator going down, and this week has been a classic illustration of that adage.
On Tuesday evening at 6pm ET, Nadex opened with fresh new strikes for the following day. The markets closed bearish that day for the 2nd consecutive day, so the decision was made to follow the prevailing down trade, but also to choose a strike price that would reduce my exposure for risk, while maximizing potential gain.
I placed Limit Orders for the following US Equity Indices:
In total, I had $600 tied up in risk on the US Equity Trades. By 8:30am ET, I closed those trades out for $965, representing a 160 percent return on capital risked overnight.
Not a bad trade to wake up to. I decided to cash out with a handsome profit simply because there was no way of telling what the markets would do after the Opening Bell.
This was a low risk, high reward approach to trading uncertainty in the week prior to the General Election.
This was a low risk, high reward approach to trading uncertainty in the week prior to the General Election.
