By definition, a pullback is a contradictory move in price from a periodic extreme. Pullbacks may be bullish or bearish in nature, often creating premium opportunities to trade futures when they occur. If you’re interested in trend-following strategies, then understanding pullbacks is a great place to begin.
Step Up and “Buy the Dip”
Throughout the past three-plus years in U.S. equities, the phrase “buy the dip” has been worn out. In fact, if you’ve ever spent a morning watching CNBC or the Fox Business Network, the expression is likely old hat.
But what does it really mean to “buy the dip”? Essentially, to buy the dip is to take a new long position on price falling from a periodic high. Assume that the S&P 500 posts a fresh top above 3,500.00 before quickly retreating to 3,250.00. Investors would buy the dip by going long on the S&P 500 somewhere in the vicinity of 3,250.00. The goal is to profit from the S&P 500’s bullish trend by buying the index at a discount.
The beauty of this pullback strategy is that it isn’t limited to stock investors. It’s also a staple for many market professionals who trade futures. In fact, buying dips in a deferred-month E-mini S&P 500 or Micro E-mini S&P 500 futures contract generated windfall profits during the COVID-19 pandemic. Here’s how:
- During February and March 2020, September 2020 E-mini S&P 500 futures fell from an all-time high of 3,396.00 to a panic low of 2,165.50―a crash of more than 36 percent.
- From March 23 to June 26, the September 2020 E-mini S&P 500 posted a furious rally from the panic low (2,165.50) to a close of 3,007.00.
- During this period, traders had many opportunities to strategically buy dips. A very basic one was to go long from psychological support barriers, such as 2,750.00, 2,500.00, or 2,250.00.
The example above is an oversimplification courtesy of hindsight. Yet those who decided to trade futures and buy the dip in U.S. equities made huge profits during the COVID-19 panic of 2020.
Sell the Dead Cat Bounce
Flexibility is one of the key advantages of futures markets. Profits for those who trade futures are not limited to the long side of the market―there’s just as much money to be made by selling distressed assets.
A “dead cat bounce” is a temporary recovery in an asset’s value following a significant plunge. The key thing to remember is that the recovery, or pullback in price, is temporary. When it’s over, the downturn continues, taking asset prices to new lows. This phenomenon frequently gives bargain hunters false hope and provides sellers with premium trading opportunities.
Perhaps the best thing about trading pullbacks is that they may be executed on any time frame. To illustrate, let’s take a look at how intraday traders could have sold the bounce during the March 23, 2020 session. Even though it was not the front-month contract and volumes were extremely light, we’ll use the September 2020 E-mini S&P 500 for educational purposes:
- During the U.S. overnight session of March 22-23, September E-mini S&P 500 futures extended the previous day’s losses. The market opened gap-down, falling to an overnight low of 2,165.00.
- In the immediate pre-market hours, optimistic sentiment began to dominate the market. Bulls piled into the September E-mini S&Ps, driving prices to a high of 2,375.00 around 8:30 a.m. EST.
- Shortly after the Wall Street opening bell at 9:30 a.m. EST, extreme selling ensued. By mid-session, the September E-mini S&P 500 was trading 2,172.75―a massive three-hour sell-off.
The March 23, 2020 pre-Wall Street open brought a steep rally to U.S. equity futures―an epic dead cat bounce. Savvy individuals took the opportunity to trade futures and short the pullback ahead of the intraday return to overnight lows. They were rewarded with extraordinary profits and a session for the ages.
Using Pullbacks to Trade Futures
Are you interested in learning to buy the dip or sell the bounce? Well, the best way to achieve competence in any discipline is through repetition.
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