Recovery headlines versus trend-regime rules

A classroom on regime-identification

This archive article is a TradersWeek editorial. It uses a historical workflow as a classroom on regime-identification: the task of deciding whether a bounce is a reversal or only a correction by inspecting the overall-trend, not by accepting popular turnaround talk.

Market location cannot be known with complete certainty, so expectations have to be expressed as probabilities. A technical approach bases those probabilities on price. Price-based-probability is that practice. It states market expectations as likelihoods inferred from price rather than as a claim of a certain destination.

Bubbles that price can record

Price is produced by other participants' actions, and those actions sometimes create a bubble. A bubble is a price episode produced by participant behavior that can depart from typical conditions and later unwind with broader effects.

A housing and credit bubble was already described as having burst, with significant economic effects. Loose monetary policy was said to have allowed debt to accumulate, contributing to a US housing and credit crisis. The immediate impact was described as still concentrated in the US, with later spillover expected, especially into emerging markets. A food and energy bubble was described as forming, with resource supplies expected to tighten further.

A bounce is not a new overall-trend

Widespread belief that the credit crisis had already bottomed was treated as insufficient to decide whether a bounce was a reversal or only a correction. That belief does not complete regime-identification.

A bearish regime can include corrective bullish rallies that create short-horizon speculative chances without ending the larger downtrend. A corrective-rally is that countertrend bounce inside a still-bearish regime. The overall-trend is the larger directional regime that stays in force until price structure changes, not until a recovery narrative appears.

Keep the procedure on the governing trend

While the overall-trend stays bearish and short opportunities outnumber long ones, the market is still treated as a bear market. The argued response is to study that trend rather than act on unfounded recovery stories.

Editorial reading: trend-following is a single procedure that keeps entry, exit, and abstention aligned with the governing price trend instead of with claims that the worst is already over. Recovery headlines are not allowed to stand in for a change in price structure.