OK this title may be a stretch but stay with me because while the title is not significant there is an important set of lessons to learn.
I was a big Steven King fan in my younger years and read every book he wrote. Without retelling the entire story and giving it away, Pet Cemetery was the story about a family who buried “things”, initially starting with a pet that had died, in their backyard. The twist was those “things” that got buried eventually came back to life. As you will see below, the aforementioned “dead horse” of last week’s post, GDXJ, must have been buried in the main characters of Pet Cemetery’s backyard as has risen back to life.
Most times I don’t cover potential outcomes that would be different than the point of my post. This is partially because I try to keep my posts short and succinct but also because I can’t, due to SEC regulations, provide investment advice to the “general” public. So the more information I provide the more it could be deemed advice or a recommendation. So I walk this fine line always wanting to insure regulatory compliance. These post are just to provide ideas as I expect anyone reading will be doing their own due diligence and to determine if it works for them. What I left out of last week’s post was the possibility of what is known as a bear trap, or in other words a case where my horse wasn’t really dead, just severely wounded. Let’s take a look at the chart I posted last week which showed GDXJ breaking down below the $18.2 major support level and see if I can show you the bear trap. These are not rare, one-off occurrences as such are important to recognize and understand because they happen often enough, especially in small, thinly traded markets.
A bear trap is where the market makers sell some of their inventory to push price below a level of very visible major support. This has the following effect; those that were long the security see this support level being broken and sell their shares to cut their losses. This selling helps to drive prices lower. Those that were bearish but waiting for a break below support, pile on short adding to the downward pressure. Once this plays out then comes the short squeeze or bear trap. Usually within a day or two of the support break, those same market makers who sold some shares to start the cascade lower, begin buying back shares trying to push price higher. The try to buy only enough to move price back above the prior support (which has now become resistance) level. Once that happens, those that had piled in short are forced to close out their short positions, adding fuel to the buying frenzy driving prices higher. Those, sneaky market makers make money by playing the investors emotions knowing how most will act because the fear of losing is a very powerful motivator. This is exactly what occurred with the miners as you can see in the updated GDXJ chart below.
There is a saying that from false breaks come big moves. This was a great example of a false break so we have to be open to the fact this move higher could be substantial. For now, I do not waiver from my bearish long term view that we will eventually see lower prices. For now, we will rally from an oversold condition allowing the market makers another chance to unload some shares at higher prices before it falls again. Until proven otherwise this is just a short squeeze, counter-trend bounce in a bear market.
So what’s the “take-away” from this example?
· There is always the chance you will be wrong so it’s an absolute requirement to have your course of action mapped out BEFORE you enter into an investment, in case it goes against you. There is no one action plan that works for everyone so yours should be based upon your investment style, risk tolerance and time period used.
· Being wrong is OK as it is a part of investing and a potential outcome any time you put capital to work in any market. Staying wrong is not.
· Cut your losers quick and let your winners run. Over the long haul this is how you insure long term out-performance, lower risk and preserve investment capital.
· Waiting for confirmation (2nd and 3rd day follow through to the downside for example) can greatly improve success rate but will lessen any gains.
· Steven King and investing may not be a great combo, not unlike a strawberry Popsicle with ranch dressing.