You Know The Drill

Another down week in the market.

Risk management remains the priority.

I admit—it can be lame.

It’s much easier to run some all-time high scans and post those charts.

If only it were that easy.

My work starts with the market environment first, then determine the strategy.

Breadth and other tools help answer the real question: should we be thinking about making money or preserving it?

We want to be fishing in the right ponds.

When there’s no fish, we try not to waste too much bait.

Just take a look at the S&P 1500 breakdown by market cap:

 % Above a 200 Day Moving Average

Large Caps (S&P 500), Mid Caps (S&P 400), Small Caps (S&P 600)

All three have the majority of their stocks drop below their 200-day moving averages, hitting new 16-month lows this week.

This is a capital preservation market.

The bright side? We’re likely getting closer to a bottom.

But this is a prove-it market now. I need to see the evidence.

If not, check out last week’s note.

Capitulation and Follow-through.

Two historical commonalities of stock market bottoms.

We’ve seen signs of capitulation, but follow-through?

Not yet.

The S&P 500 hasn’t had back-to-back green days in over three weeks.

Friday’s close was strong, but it’s just a start.

We NEED follow-through.

I’m looking for a string of up days...is that too much to ask?

Combine that with broad participation, and you’ve got the setup for a solid trade.

Here’s a chart that highlights that idea:

This chart covers a lot, so let’s break it down.

Capitulation and follow-through are key, but another thing it highlights is the tendency for fakeouts around key levels.

That’s capitulation at work.

Buyers sell, then get trapped. It’s unavoidable in markets.

There are two types of traders: those who get faked out and those who lie about it.

Managing risk at key levels makes sense, but what often gets overlooked is the need to step back in once those levels are reclaimed.

You can’t be afraid to take another swing.

Many of these fakeouts are followed by broad participation as buyers step back in.

That’s exactly what we want to see.

A solid first step?

Getting the percentage of stocks above their 20-day moving average back above 30% and price following through above $565 to confirm this fakeout.

That’s likely where I’ll take my swing, using recent lows as my stop.

NOTE - I’m exercising extra caution here since this setup is happening below the 200-day moving average.

Taking trades below the 200-day requires keeping risk management at the forefront as the longer-term trend is still under pressure.

This chart was also featured as the Chart of the Day for The Chart Report, where you can find additional analysis.

Is this Method Perfect? No.

If you have a perfect method, send it over. Seriously.

What this approach provides is a logical, actionable framework.

It stacks the odds in your favor with well-defined risk.

That’s what this game is about.

Mistakes are inevitable. The goal is to keep them small.

Ned Davis, founder of Ned Davis Research and author of Being Right or Making Money, said it best:

Technical analysis helps quantify those potential mistakes.

You might be wrong, but as long as the loss is small, that’s fine.

So when the right setup comes along with favorable risk and reward, step up and take the swing.

Check out my Friday weekly show with my friends at Stocktwits!

This week I layout what “follow through” looks like in real time along with some of my favorite setups.

Put it on 1.5x speed and let me know what you think.

Likes and Comments also help!

As I mentioned a couple weeks ago the support here has been unreal.

People subscribing and sharing my work keeps opening doors—helping me improve what I do and bring even more value to those who support me.

Keep an eye out for my new research column, “Thompson’s Two Cents.”

I will be dropping my two cents every Tuesday and Thursday.

Cheers,

Larry Thompson, CMT CPA

Follow Me On Twitter (X)

Follow Me on StockTwits