A Valuable Lesson to Learn from 2010 Support Range Break

Oct 10, 2011: 12:42 PM CST

I’m a huge believer that “history repeats,” and one can often see similar situations developing now that formed in the past.

True, nothing repeats with exactitude, but you can often learn lessons – mainly about assumptions and outcomes – from studying similar chart formations that have developed in the past.

Let’s take a look at something that developed in 2010 that looks eerily similar to what’s going on right now:

As I’ve carefully shown you in prior updates, the market is bounded by a dominant sideways trading range:

October 7:  Market Structure and Current Trading Range (with Bear Trap)

October 3:  “Bigger Picture” of the Current Trading Range

While traders are more concerned about “what’s going on right now,” it can help you to learn a lesson from the LAST time price was in a very similar situation.

Let’s start with the May “Flash Crash.”  Price plunged roughly 200 points from 1,220 to 1,040 to settle into a sideways “Trading Range” between 1,040 and 1,130 (roughly 100 points).

The “Midpoint Fair Value” price developed at 1,090.

Over the next few months, price traded within the context of this range, though it slipped out temporarily in a “Bear Trap” as July 2010 began.

Traders who logically short-sold under 1,040 were forced to buy-back to cover their losing position, which resulted in a “Popped Stops” burst BACK into the Range (stopping at the 1,090 value area).

That’s almost identical to what happened on October 4th (2011)’s “Bear Trap” recently.

If you remember the headlines and sentiment during this time, the prevailing discussions was on whether the US (and global economies) was headed for a “Double Dip” (second) Recession and whether the “European Sovereign Debt” crisis would spread or would be solved (mainly focusing on Greece and contagion of a default).

I need not tell you what the dominant headlines are at the moment:  US/Global “Double Dip” and Europe Contagion centered on Greece.

History repeats.

Then, as in now, the dominant sentiment was bearish, with many analysts calling for an inevitable market collapse/crash as a second recession began.

That’s not what happened.

Instead of crashing, the Federal Reserve again engaged on a second round Quantitative Easing (designed to prevent deflation by creating/manufacturing/manipulating inflation).

Then, the stock market stabilized then ejected to the upside in a powerful day-over-day rally as stocks broke the upper resistance… ending with May 2011’s peak of 1,370.

Of course, shortly after Quantitative Easing #1 ended, the market crashed;’ likewise, after QE2 ended, the market “Crashed.”

Whether coincidence or not, history repeated.

That now takes us to the current chart with a very similar situation:

We have a similar 200 point “Crash” in August which then resolved in our current “Trading Range” between 1,220 and 1,120 (also 100 points).  Fair value continues to exist at 1,170.

I’ll let you draw your own conclusions, but the big lessons that come to the top of my mind are this:

1.  History Repeats

2.  Outcomes are NOT always what are assumed

3.  Bias Hurts

Then as now – or at least as of early October – an overly bearish bias has hurt traders, even though that seems the most logical assumption.

Those who were overly bearish did not react to the reality of the sideways trading range that developed, including the neutral boundary ranges as labeled.

When the market goes up when it “shouldn’t,” (at least according to the majority sentiment), it can be painful both to trading accounts and to logic, resulting in confusion (“Why is the market doing that?!”).

Ironically, due to “feedback loops,” and “short-squeezes,” the more BEARISH sentiment gets, the more powerful the upward rally can be when expectations are not met with market outcomes.

Of course, this logic works in reverse when the majority are overly bullish – it’s the foundation of Sentiment Analysis.

This means that when lots of traders are positioned short, continued upward movement in price eventually forces them to cover their short-positions which is a BUYING activity.

Anyway, study the development of the 2010 trading range, compare it to the current range, and expand your awareness of pattern repetition and market structure – free of bullish or bearish bias.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

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Comments
  • Totally different situation this year.  No QE.  If you look back over the SPX chart, the market hasn't risen for more than a week or two when QE wasn't in place or about to happen.

  • Great stuff Corey.  Can you elaborate on the difference between a "bear trap" and a "failed breakdown"?  At what point does a bear trap become a failed breakdown (or vice versa) and are the terms interchangeable?

  • Good question!

    Bear trap is just a more memorable/colorful word fir failed break - they mean roughly the same thing.
    Price needs to close one or some would say TWO days beyond a level to count as an official break, or perhaps close 2% or 2 ATR functions outside the price level to be official. Then again, trading strategies depend on the aggression level/threshold of the individual trader when making a decision regarding a prospective break in real time.

  • Thx. I've just about finished Charles Kirkpatrick's book on Technical Analysis (studying for CMT I) and vaguely recall a brief description of both terms so just wanted to get your take.

  • SeanT.

    What would you be looking for to develop a more short-term bearish outlook?  Nice analysis BTW...

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