Yesterday (Wed. Aug. 6th) it seemed to some that the market was bouncing back quickly this week to regain territory lost since the sell-off that began on July 20th and reclaim the 14,000 DOW crown. But not so fast. Corrections take time to resolve. A “real” correction usually will take a month or more. Hence it is no surprise that this morning the market is down. This correction simply ain’t over yet, pard. That’s why we’re seeing so much instability and triple-digit up and down days.

So, what is a “real” correction? It’s one that reaches a classic fibonacci retracement level and that everyone afterwords believes to have actually been a correction. The reason is: that belief is the key to humans committing to actions that take the market to new highs. We’re getting into psychology a bit here, where angels fear to tread; but since it is humans (for the most part) who trade and therefore create bull and bear markets in the first place, psychology is very important. Imagine a 50% retracement that resolved from top back to top in three days. Though a classic fibonacci level was hit, would enough people believe that a correction had occurred and resolved to act upon it? I think the answer is NO; only the most optimistic could believe it. And if unconvinced, everyone continues to wait for the “real” correction instead of committing more money. This lack of support eventually results in the correction reaching the final stages.

A correction that resolved in a week or two would therefore not be terribly convincing. As Exhibit 1, your honor, I submit the earlier 441-point market dip in June of this year. It simply was not as large as it should have been and resolved far too soon (two weeks)… for a “real” correction. And rather obviously, nobody believed that it was the real thing, else we would not be having the current one.

Look at the correction in Feb/March of this year, by contrast, in which it took 6 weeks to regain the lost territory. Since the reason that corrections work and allow markets to go higher is rooted in human psychology, a correction is “real” only if it is large enough and unfolds slowly enough to command respect.

We’re 20 calendar days or so into this correction, which has been far more volatile than the one from March, comparing candle sizes. If I am not very much mistaken, there is more to go, perhaps weeks, with big swing days, until a resolution finally occurs. I think that resolution will be a temporary continuation of the bull, but whether that occurs and how long the bull can then run is anybody’s guess. Be that as it may, I don’t think we’ve seen the bottom of this correction.

TRADING THOUGHTS:
Those of you who still have covered call positions open now (bless you) should be trading the calls as the stock moves. When it pulls back, close the call, rewriting it when the stock moves back up. Rather than being intimidated - or scared plumb out of the game - by this correction, trade it.

As always, if you fear the bear market has already begun, buy a multi-month put, as discussed in prior blog posts.

This entry was posted on Thursday, August 9th, 2007 at 11:02 am and is filed under Markets/Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.