How Market Correction Played Out, Where We Go From Here

The S&P 500 had a rocky start to the year. Our swing trading rules largely kept our exposure low and created outperformance as a result. Here’s how we’ve handled the year thus far using the SPDR S&P 500 (SPY) as our S&P 500 market example.

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S&P 500 Starts Year Weak

An important signal of trouble on the S&P 500 came early in the year when the index punctured its 50-day line (1). Keep in mind, that many growth stocks were already showing weakness since February 2021. But that weakness was largely masked in the market indexes by strength in megacap stocks. Names like Microsoft (MSFT), Apple (AAPL), Alphabet (GOOGL) and Tesla (TSLA) are at the top of that list.

This time was different, though. Like many of its drops throughout 2021, the S&P 500 quickly reversed higher. But the rally lost steam after just a few days with resistance at its 10-day moving average. The megacap names also started seeing breakdowns below their 50-day lines. As a result, the S&P 500 saw a swift decline before the Jan. 24 reversal (2).

Given our low exposure and cushion of outperformance so far for the year, we entered a brief trade that day in the ProShares Ultra S&P 500 ETF (SSO) on SwingTrader. We took profits into strength but closed it to keep it profitable a few days later. Then we switched into the Invesco QQQ Trust ETF (QQQ) when the rally resumed (3). It didn’t qualify as a follow-through day but it was a day of power.

Here again, we took profits into strength and exited at the first sign of trouble around the 21-day line (4).

Light Exposure On Another Wave Down

Even though we had a follow-through day eventually, it’s important to remember they don’t all work. The S&P 500 ran up to its 50-day line and hit resistance there. The subsequent drop eventually made a new low on a stunning Feb. 24 reversal day (5).

On this week’s Investing With IBD podcast we talk about the sharp snap back in beaten down stocks and what it means for the market.

We tried another index trade with SPY stock (6) but got shaken out as the Nasdaq composite undercut its Feb. 24 low (7). What’s notable is that the S&P 500 didn’t undercut its lows and that left the rally attempt intact.

As a result, the S&P 500 notched a follow-through day when the Nasdaq composite was out of position for the signal (8). We responded by increasing exposure to more than 50% invested for the first time since the beginning of the year.

Where Do We Go From Here?

Our focus continues to be on stocks with strong relative strength lines, many of which are in commodities. Those areas are mostly extended now. As for the indexes, they’ve been driven higher largely by stocks with the worst relative strength lines. It seems like a market that could go either way and we have our exposure at 50% as a result.

With the S&P 500 getting back above its 200-day line (9), we are hoping for a pause here. That can allow some of the destroyed charts a chance to show tight action and give a breather for the extended stocks. If this rally is going to work, there will be plenty of opportunity for more trades. If it rolls over here, our half exposure should again prevent us from getting hurt.

More details on past trades are accessible to subscribers and trialists to SwingTrader. Free trials are available. Follow Nielsen on Twitter at @IBD_JNielsen.

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