Sentiment Analysis Doesn’t Work in Bear Markets

In bear markets, one thing is certain — traders are looking for counter-trend bounces. It is a very understandable phenomenon as bear market bounces tend to be very tradable and traders are strongly inclined to do something productive when conditions are this miserable.

There was a brief try at a bounce on Monday. It fizzled out quickly and the S&P 500 ended up pushing to a new closing low for the year. The June lows are very important technical support for the market and they are now being tested. Typically, undercutting those lows will trigger a stop run that washes out the selling pressure and produces some sort of bounce.

Traders justify the bounce by claiming that sentiment is extremely negative and market participants are very poorly positioned. Jim Bianco of Bianco Research notes that in a bear market no extreme sentiment is too extreme. Sentiment analysis fails in bear markets, and we have seen several examples of that in recent weeks. Oversold conditions have not mattered.

We will see how the bounce try here on Tuesday develops, but the most important thing to keep in mind is that there is no need to rush to build longer-term positions. I’ve been harping on this point recently, and I want to continue to reinforce it. We are in a bear market, and even if today is the absolute bottom that doesn’t mean you will miss out if you are not loaded with longs. There will be weeks and months to build positions as a recovery develops. The charts will take time to develop and there will be very bumpy and volatile action for quite a while before a strong uptrend develops.

Don’t be too concerned about the exact timing of counter-trend bounces. It is great to trade them if your time frames are very short, but they are really just noise within the big picture. Traders and pundits have to do something as they stare at the market all day, and becoming excited about a bounce is about the best they can hope for.

Be clear about your time frames as you navigate this action and don’t waste your time wondering if a significant bottom is forming.

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