Bear markets more than any other markets are made up of risk-on and risk-off days … and weeks and even months. Correlation spikes, which pushes most stocks up and down together.
The selling spree since late December has pushed a host of sectors into bear market territory, including the financials. Shares of Wells Fargo & Co (NYSE:WFC) fell just about 20% into last week’s lows, where they quickly staged a notable bullish reversal.
Active investors and traders could look to take advantage of it to play a counter-trend rally.
As a general investment theme, it is well-documented that traders and investors for the most part are better off not fighting the medium-term trends in markets. That is, when the trend is higher, it pays to buy the dips; when the trend is lower, it pays to sell or sell short into the rallies. This simple strategy can keep investors from making costly and frustrating mistakes over time. (So, write that down.)
In bear markets, however, the general spike in fear and thus increased correlation presents the more nimble investors opportunities in both directions. Take the 2008-09 financial crisis bear market, for example. Fear and correlation ran high, and as a result we witnessed plenty of so called bear-market or counter-trend rallies that in the S&P 5oo measured 10%-15%.
A counter-trend move of this magnitude for a large and important index such as the S&P 500 is something that active types can sink their teeth into. Just make sure that, all the while, you keep in mind that until proven otherwise, the rally is counter-trend and thus must be sold into.
Wells Fargo Stock Charts
The price action for WFC stock through much of 2014 and 2015 formed a big head-and-shoulders-like pattern, which has a horizontal neckline at the dotted line on the weekly chart below. Currently this “neckline” also happens to coincide with the 2009 support line, which WFC stock has not touched since the year 2012.
The topping formation ultimately should lead to lower prices and gravitate WFC stock toward the blue zone on the chart (the $37-$40 area). In other words, the primary trend continues lower, and any rallies should be sold or sold short into.
Moving on to the daily chart, we see that from a momentum perspective (as represented by the MACD oscillator at the bottom of the chart), WFC stock reached extremely oversold readings in January. After a little bounce in late-January, however, Wells Fargo’s price continued lower; last week, WFC made a lower low against the January lows, but momentum made a higher low. We call this positive divergence, and momentum often gives the truer signal.
Note also that last Thursday that Wells Fargo stock gapped lower, only to completely reverse direction on Friday by gapping higher and rallying to the tune of nearly 5% on the day.
Trained market technicians will also refer to this price action as a morning star pattern, which for the near-term tends to have very bullish implications.
Active investors could look to buy WFC stock near $47 or higher for a move back toward $50, while using any sharp bearish reversal of last Friday’s rally as a stop-loss trigger.
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