The coronavirus pandemic is causing devastation in the global marketplace, especially businesses in the automotive and aviation sectors. Shares prices in some parts of the economy have been declining for several weeks. Investors holding declining shares are anxious to get rid of them before hearing or reading about this or that company’s demise.
In this current economic climate, protecting investors’ portfolios is still a top priority. However, how can you shield a person’s or company’s investment portfolio effectively in such a volatile and bleak market?
For the amateur trader, the perfect time to take effective action is when asset prices are going up, i.e., when there is an uptrend. However, as the above example demonstrates, a drop in prices, which investors commonly refer to as a downtrend, can also be a cue that a sale might be in order. This article illustrates how any trader can make a decent profit in the event of such a downtrend. In other words, it really is possible to make money in a bear market – let’s find out how.
The Composition of a Downtrend
Before we jump into the subject of what a downtrend is and how it functions, consider these three changes in the price of a $20 stock:
- Stock price falls to $17
- Stock price rises to $18.50
- Stock price falls to $18.20
Each of these price fluctuations is called a price wave which can be further classified into two different forms:
- Impulse waves (resulting from larger price differences such as $20 to $17 or $17 to $18.50)
- Corrective waves (resulting from smaller price differences such as $18.50 to $18.20)
Through the combined action of these two waves, prices can keep moving in one direction or other thus establishing trends seen on forex candlestick graphs.
With these basics established, a downtrend is thus defined as an impulse wave downward accompanied by a smaller upward corrective wave. As this upward corrective wave is not large enough to offset the downward impulse wave, the net effect is a drop in the price of the asset.
A forex candlestick graph will showcase a downtrend as an order of lower highs (corrective) and lower lows (impulse) as the curve progressively moves lower down the y-axis from left to right. Thus, the continuity of this price wave pattern will sustain the downtrend.
Signs that the Downtrend is in Danger
As we have mentioned before, the central requirement to maintaining a downtrend is a combination of downward impulse and upward correction waves. However, if the waves start expressing opposite qualities where the impulse wave faces upwards and the correction wave faces downwards (higher highs, higher lows), this may counter the downtrend.
In fact, these price waves may be unpredictable since at any time the price may move towards a downtrend, or show signs of reversal, then shift to an uptrend or a downtrend. In some cases, both the impulse and correction waves are of same sizes leading to a horizontal/sideways trend.
Despite these irregularities, remaining updated and closely analysing current impulse waves , you will have a clear idea about the direction trend may be moving next.
Trading Strategies to Help You Profit off the Downtrend
The following are a detailed set of steps that will help guide your response to a downstream in the market for any asset:
1. Pick a Time Frame for the Candlestick Chart of Your Preferred Security
Transaction charts can come in two major time frames:
- Short term charts such as the tick chart is ideal for detailing minute trends for large transaction volumes whereas the one-minute chart is ideal for detailing minute trends for lower transaction volumes.
- Long term charts such as the daily, weekly, or monthly charts are ideal for detailed information on trends for trades spanning months or years.
Hence, you are advised to pick a chart whose time frame suits your current trading needs.
2. Short-Sell at the Same Time as the Corrective Wave
The chart may be signalling an upcoming downtrend, if the succeeding impulse waves are larger and moving further down the y-axis than the previous impulse waves. This is because corrective waves are often not large enough to offset such big changes. Assuming that the trend will continue, it is advisable to short-sell in the middle of the next corrective wave.
To enter the trade at this point, you can use a plethora of techniques, most notable of which is the Fibonacci retracement, widely used to pinpoint where the corrective wave may stop and turn around. Otherwise, traders can choose to bid their time for the corrective wave to stop ascending and start moving horizontally.
Once this wave shows signs of descending, use the opportunity to get into a brief trade.
3. Use the Stop Loss Order to Control Risk
The stop loss order is given to a broker on behalf of the trader to purchase or sell a security once it gets to a certain price. This protects the trader from the risk of loss if the price of the stock falls below the stop price. Using this order is extremely helpful in case the impulse wave will continue to become larger and dip lower then the expected assumption
Normally, the best course of action to leave the trade with a profit is to position the price target near the previous impulse wave. However, this target position may differ based on the strength of the downtrend. A strong downtrend (large lows) means that this target is positioned below the previous impulse wave whereas weak downtrends (small lows) means that the target is positioned above the previous impulse waves.
Get a Professional Opinion to Learn More and Fine-Tune Your Trading Prowess
Before you head off to use all this wealth of information, consider your current trading skills. If you have been doing this and failing for years, you may not have enough experience under your belt, and one mistake in this trading world could lead to potentially big financial losses.
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Conclusion
A downtrend is a result of the occurrence of larger downward impulsive waves followed by smaller upward corrective waves. Traders should learn to look for signs of a downtrend in the charts and act by short-selling during correction waves to maximize monetary gains in the downtrend. Remember to have a stop loss order in place to protect yourself and know your exit strategy preferably done through setting price targets near previous impulse waves.
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Interesting related article: “What is a portfolio?“