Retail traders often say when markets seem overextended (or overbought) that they will buy on the next pullback. They may even make a watchlist/wishlist of stocks they will buy if the market just gives them a normal run-of-the-mill 3-5% pullback. But when the moment they claimed they wanted finally arrives, and the market pulls back, the retail trader may freeze and almost instantaneously turn bearish, joining the permabears who believe the market is on the verge of a crash or collapse.
Everyone says they want to buy low and sell high. Everyone says they want to buy when there is "blood in the streets." Yet when the opportunity presents itself, many traders will freeze up, automatically assuming that something has fundamentally changed that now makes buying the dip (or substantial pullback) a risky idea. In the case that something really has fundamentally changed, then we really do want to be more cautious in hitting the 'Buy' button.
If a dip or correction finds support at a crucial level, such as the 200 day moving average (200MA), then do we really have a valid reason to not look to go long stocks that have a favorable risk to reward ratios?
We saw two events in 2016 that gave traders and investors incredible buying opportunities. The first was the Brexit vote in the United Kingdom, which led to extreme levels of bearish sentiment. After a brief correction following the vote, the S&P 500 hit the 200MA and then bounced to new all times highs. A few months later when Donald Trump won the US presidential election, the market had dropped again and found its way back to the 200MA. Some of the most well respected traders were claiming that a Trump victory would lead to at least a 10%+ decline in the market. But Instead, we saw a rally to new all times highs as the S&P 500 hit 2,300 and the DOW went past 20,000.
Despite the bearishness so many traders and analysts had about both Brexit and a Trump presidency, the 200MA served as solid support. When a support level is established like this, you have a clear opportunity to buy the dip. If you had bought the dip after Brexit and the US presidential election, you could have placed a stop loss order beneath the 200MA, so that if that level of support had been broken, you could have easily exited with a small loss.
The point is that we often claim that we are going to buy the next dip/pullback, but we ended up capitulating and giving in to bearish sentiment when there is no good reason to do so. When sentiment gets too bearish, yet the market shows resilience, it is usually a good time to look for some buying opportunities.
As I write this -- on May 12, 2017 -- I am expecting a pull back to come soon, though I expect it to be rather shallow. I think we could pull back the S&P 500 (SPX) could pullback to the 2280-2300 region, although I am mindful that the pullback may be much more shallow, provided there is much of one at all. It could be that we continue to melt up into the 2450-2500 level before there is ANY real pullback or correction.
If there is a pullback , I will be a buyer of good stocks.
If there is no pullback, I will not chase and will just miss that upside.
I would rather miss that upside than buy at the top.