In recent years, one of the biggest technical changes in the stock market is a greater tendency toward V-shaped bounces. Time and again, we have seen the market recover in a straight line after a sharp decline. In the past year, it occurred in February, May and July of 2018 -- but those V-shaped bounces are dwarfed by the current bounce that started on December 24.
Traditional technical analysis tells us that the market should not go up in a straight line following a sharp selloff, for two reasons. First, market players that were caught in the selloff are more inclined to want to escape positions that caused them great pain and distress. When they able to dump a position that has caused them sleepless nights with a much smaller loss than expected, then they are inclined to do so. That is what overhead resistance is all about.
The second reason that market's don't usually go straight back up is that the bears, who are emboldened by recent success, are more inclined to initiate new short positions and try again. Traditions technical analysis suggests that there are retests of lows and difficulty overcoming resistance, so the odds of shorting would seem to be favorable.
The market's tendency to not produce V-shaped bounces has changed in recent years for one primary reason -- computerized trading. For a number of reasons, the computer algorithms that drive the majority of the market action tend to favor V-shaped moves. The psychological reasons against straight-up bounces have been replaced by price-driven action that favors them.
Many market players have never been able to embrace this tendency toward V-shaped bounces. They simply don't conform with common human emotions and behavior. If you have tried to use psychology to navigate the market, you have been frustrated, as the computer algorithms are focused on manipulating that sort of behavior.
Eventually, those V-shaped bounces come to an end. But they make it tremendously difficult to time reversals. There just isn't any way to gauge how far they will run before they reverse.
In addition, the V-shaped bounces tend to come to abrupt ends. There is an old saying that tops are a process -- but that is not the case when stocks move in V-shaped fashion. The reversals tend to come very quickly and without much warning. For example, the V-shaped bounce in February 2018 ended with an intraday reversal on February 27 that led to more days of sharp drops, and ultimately gave back nearly 50% of the bounce.
The lessons of V-shaped bounces are:
1. They don't conform with human emotions;
2. They last longer than seems reasonable; and,
3. They end abruptly and without warning.
The current market is at the point where most reasonable people would question its ability to continue to go straight up, but there are no signs yet that it is about to relent. It may be overbought and running into technical overhead, but that has been the case for a while. The most likely clue that this move is coming to an end will be a sharp intraday reversal -- so stay vigilant and be ready to react quickly.