Identifying a Sucker Rally
Identifying a sucker rally can be challenging, even for experienced traders. Sucker rallies appear and disappear without warning, especially during a period of downward-trending market action, such as a bear market.
A bear market is typically indicated by a 20% drop in the stock market, and tends to occur when the market is overvalued. At the time of this blog being written NONE of the major indices are off more than 15%. The R2K is down roughly 15%, the Nasdaq is off a little of 14% and both the Dow and S&P have bounced back from correction territory. During a bear market, investor confidence tends to be low, and traders watch eagerly for signs of upward movement in the market. Inexperienced or panicking investors may be tempted by market upticks, making these investors especially vulnerable to the whims of a sucker rally. They want to buy because they don't want to miss out on any upside that may develop… Please don’t let FOMO dictate your trading decisions!
Prevalence of Sucker Rallies...
Rallies are common occurrences during bear markets. Just like the old saying goes…”what goes up, must come down”. Well, in a bear market of bearish move..” what goes down, must come up”. I honestly just made that saying up. But the reality is, no matter what side of the market you play, there are always counter moves! Notably, the Dow Jones Index experienced a three-month rally following the Stock Market Crash of 1929, although the overall bear market continued on a greater decline until bottoming out in 1932.1
Bear markets frequently spawn at least one rally of 5% or more, but then proceed lower, before the market begins an uptrend. On February 24th and 25th collectively we saw a 6.5% rally…with that said we’re still in a technical Bull Market…In the grand scheme of things though, bear markets can have at least one, and usually more, sucker rallies.
Because bear markets may last for long periods of time, they can exact an emotional drain on investors hoping for a market turnaround. Traders shouldn’t get too effected by the slide lower. Our job as traders is to take advantage of whatever market we’re given. Market advisors warn against emotional responses to market volatility, as investors may panic and make judgment errors regarding their holdings. Shit happens! Many experienced traders wait to see the price make a series of higher swing highs and higher swing lows before buying. The series of higher swing lows and highs helps identify that an uptrend may be underway and that the downtrend may be over.
Here is the bottom-line…and just something to make a note of!
Sucker rallies typically occur after a sharp decline. When prices fall significantly, it is hard for the price to immediately make new highs again. Investors are nervous, and their confidence is shaken, so when the price bounces astute investors and traders use it as a selling opportunity.
These bounces are called sucker rallies, since they are likely to be met with overwhelming selling relatively soon after they start.
Two sucker rallies occurred in 2018 after the S&P 500 witnessed a sharp decline of more than 11% in October. The S&P 500 then rallied almost 8%, but this was quickly met by more selling. The price then rallied more than 6% off the swing low, but again this was met by selling and a large drop in price…Just keep your eye open and you emotions in check. Apply your trading edge and manage your risk on every position!