Understanding the bear market rally.

Finding good trade entries and avoiding common traps.

Lots of people are talking about bear market rallies now. Lots of stats on how many there tends to be in a market, what percentage previous ones were. Lots of content on bear market rallies. While a lot of it is interesting, I do not see much of it as practical and have real utility in the real swings of today.

“Average” of anything in the market can be misleading. A river can have an average depth of knee-height but you still drown in the middle (Clever analogy. Took it from someone else, I’d credit them if I could remember who). I want to look at real things to do in the real market that have a tested edge.

To try to establish some “Creds” as someone who can really give useful insights to bear market rallies (Since talking about them is popular now), everything covered in this post is going to be a re-iteration/slight re-write of content posted in early 2021 - While we were heading into the height of meme mania.

Understanding the bear market rally

Understanding the bear market rally, part 2

Typical stages of a market break

All of the above posts were written when we were in the time of everything expected to be a “Short squeeze” - Which in many cases it turns out it was, but a “Short squeeze” is often something that comes before a big short.

Here’s a recent post on bear market strategy posted on Reddit. We’re going to cover all the things in here through this piece so reading this is not important, but looking over the early pieces is important for context and also so you can see if I’m showing examples of trades recently I’m not curve fitting, the conditions were pre-planned.

What is the Bear Market Rally (BRM)

When you look at weekly/monthly charts of big crashes it often looks like they just came right down, but this is almost never the case. There’s usually an intense amount of drama inside of the big swings. Flash crashes into instant recoveries into utter mayhem selling through the low, only to be met with parabolic action.

Understanding how to protect profits and avoid the really nasty traps that happen through this is critical to success in trading a bear market. With a bear bet you either want to be entirely passive; Make the short, set a stop far away above a critical level and wait to see what happens - Or you want to be pretty active.

At most parts of a bear market it is going to zigzag. There are only a few capitulation swings in the whole bear market. Even during these there are small timeframe rallies. If you’re entering new shorts you’re often going to see them go well into profit and then come back to even, sometimes hit a stop loss and then drop.

How the bear market rallies are dealt with is the most important factor to how someone will perform in a bear market. Some will use them to get into good trades, and others will routinely buy highs/get stopped out shorts at highs. Watch price plummet, then “Start to recover” and repeat the process again.

Rule One: Know your 76s

See basic Fibonacci info here.

Big bear market rallies will often head to around the 76 fib of the last downswing. While not rallies will go as high in a strong downtrend, we can always be aware of where the 76 fib of the last big downswings are. The 76 fib has shown itself to be useful time and time again in all bear markets, including this one.

The nature of a bear market rally is to have soft bounces, double/triple bottoms. A bit of a climb up, and then start to really go parabolic. It speeds up as it goes and experiencing this in real time always looks really bullish. Gut decisions at this time are rarely optimal, having big decision levels planned out is much better.

Here’s a 76 fib that SPX hit in the last really big failed rally.

The juxtaposition of how simple this signal was if you’d drawn a fib (You could just set pending orders and totally forget about it) and how incredibly hard it would be to not think the market was going higher during this topping move in real time is astonishing.

That’s a really big swing. A clear 76 rejection. Then consistent downtrend to spike out the last lows. This is what we’re looking for in BMR tops at 76 fibs. Having this fib drawn on this swing was easy. Anyone could have did this. Those wanting to trade in a bear market would probably be best to get into the habit of drawing these swings.

Here we have a more recent example. We’ve picked up shorts into this 76 rally.

We’re yet to see what happens but here we can clearly define our success/failure conditions for a bull/bear move. A bear will reject the 76 (Maybe with some spike outs to 86) and then downtrend through the fibs. A bull will often pullback from 86 fib but be very strong when breaking it again.

Using the 76 levels as entries and stops above the last swing helps a lot for getting into good trades and out of bad ones. In the above example we have our stops just above the high. Most of the when a 76 breaks a larger one hits. So if we’re losing bear trades here we should not fight a parabolic move until at least the next 76.

Learning about basic fib retracements and always having the 76 fibs marked up on your chart is something I’ve found useful for determining end of corrections or start of reversal. It’s useful to know where the 76s are for entering trades, it’s important to know where they are to stop you making panic bull moves/stops into highs.

Making bullish decisions in the 76-86 fib zones of the last big downswing is the most expensive thing someone can routinely do during a bear market. If this zone is clearly broken, a new high is made and it’s retested - this is bullish. While we trade into that price zone, any bullish appearance may be a trap. Tops look bullish!

If you trade all the 76 trades the expected win rate for them in a bear market is about 60 - 65% over a large sample size. This will come as streaks. Winning and losing streaks. This is worked out on using 1:3 RR (Stop above high/target new low) - Which is considerable betting edge.

Larger signals tend to be more reliable. Trading these as intra-day/week strategy can do very well, but these do have an expected loss rate running up to close to half the trades. And these usually will come in streaks.

Rule Two: Know the bear market rally structure.

Here’s a template from the original 2021 bear market rally posts.

This is based on the Elliot wave bearish impulse leg/correction. It’s been very useful in the real market since then.

We can see on the macro SPX has made a shape resembling the template. Three main drops and a rally that spike out the last high. Into another drop.

And on the smaller charts we can see things like this are happening all the time.

When taking 76 fib entries you’re always going to pick up three signals that look good in real time but lose (Usually after a shallow drop) into this section of the trend.

At these spots the simple 76 fib strategy totally breaks down.

When we have this string of three losing signals it’s usually warning us the parabolic section is about to begin. Pack up the bear and plan to enter if there’s a bear break or where you’d be expecting to see the end of a big BMR (76 fibs). All bear signals are usually going to fail but then after the topping pattern back into win streaks.

There are ways to try to filter out losing signals at these points but as long as the market is making this sort of structure overall, I’ve found selling all the 76s with the stop above last high profitable overall. Albeit it with losing streaks. Using bigger charts will always help to produce better signals. Smaller timeframes have variance.

Rule 3: Know some basic harmonics

YouTube/Google for these, there’s so much content. You really do not need to know everything, just get an idea of the general “W” structure of a bearish harmonic.

Big tops off a BRM are often going to come with either butterfly patterns or AB=CB pattern. Below is an example of AB=CD in AAPL.

The final leg before a reversal in the harmonic (Known as the “D leg”) is always a strong, parabolic spike-out of previous highs. As with 76 moves, this always looks bullish in real time. Learning how to avoid bullish decisions on harmonics and spot the breaking of the up move if the harmonic is working are extremely useful skills.

A failed bear harmonic pattern will usually produce a strong bull move. It’s important to set your stops well as per the harmonic rules (Just behind the next important fibs). Harmonics usually work near perfectly or fail spectacularly. Both of these things are useful info, but make sure you understand the risks and set stops.

You’re going to see harmonics into the highs of BMRs on intra-day/week charts over and over again in a typical bear market. It’s good to learn about them, and if you see really big ones setting up; pay attention. Big harmonics can trigger huge market moves - often you’ll find news events linked to the moves.

Rule Four: Be patient with reversal trades.

A real top will usually advance to the highs really quickly but then enter into a long slow range. Often a spike high will come from this range and it’s some sort of harmonic. But this takes a while. Rarely less than 12 hours for a big chart reversal. Really big moves take days/weeks of ranging.

For this part I’m going to defer to the template given here.

It was written during the bull market. Has simple and practical rules and it’s shown itself to be very effective, even in mega tops like the RUT and AMZN.

Understanding the general structure of a top laid out there I think would have been useful to this point and would remain so if the downtrends continue.

Rule 5: Exit by take profit on big levels or trailing stop.

It’s best to avoid exiting a position in a bear trend because you think it’s reversing or are happy with how much money you’ve made. Always just pull the stop loss up tight to price and follow if it you want to exit. You’d be surprised how often your profit can double in a fast move right after you’d have manually exited.

If you’re picking good targets price is going to bounce big off them. So it’s best to always have the take profits set. I’ll often have my take profits set at far away prices even if I plan to exit by trailing stop. Were there to be some sort of Black Swan event, the market could hit your target area and reverse quickly - best have that set.

A lot of value is lost in bear trends by people exiting manually. If you keep trailing stops behind very recent last highs/76 fibs, it really is possible to triple/quadruple the gain without ever risking more than a tiny percentage of your running profits. To miss these, is to lose a massive edge.

Setting trailing stops for points where simple bear strategy rules fail help protect you from the bigger BMR but also keep you in the trend. If we’re in a real bear, at some point sheer capitulation tends to come - you always want to hold bear trades while the bear trend remains valid (Not breaking 76s/last highs).

Quick bullet points list for things to remember as a bear.

Using these bear market strategies give you what I think is a good overall expected edge in a bear market. This is contingent upon a suitable amount of bets on the strategy. Since there will be winning and losing streaks, betting heavily on any one event has much higher risk.

These strategies are best suited to small bet sizes, that are consistent as a percentage of the trading account and you have a tolerance for a losing streak of. As an example, betting 1% in every trade. A bear market produces many great bull/bear opportunities - but to beat the odds, you have to stop the odds beating you.

These strategies are best suited to small consistent bet sizes if using for short/mid term. Single long-term bets are viable, but the inherent risk of any speculation should be considered. I think these strategies applied on only large timeframes would be well suited for hedging long-term bull portfolios. Cheap insurance, if you will.