Market Flattening, Here’s How to Profit

by Darrin Donnelly on January 31, 2011

Click on chart to enlarge.

Click on chart to enlarge.

Chaos in Egypt caused a 4% spike in oil prices, Amazon and Ford both reported disappointing earnings, and the U.S. economy rose less than expected in the fourth quarter.  This trifecta of bad news at the end of last week took the market down sharply and ended a four-day winning streak on the NASDAQ. 

Friday’s action marked the fourth distribution day in less than one month. 

While Friday’s steep decline erased the gains made earlier in the week, the weekly NASDAQ chart (as seen in the chart that accompanies this article) shows that we have entered a Stage 3 Flattening period and have not yet entered a Stage 4 Downtrend. 

It’s important to remember that Stage 3 markets are not always tops and don’t always lead to Stage 4 Downtrends.  These flattening zones can simply be constructive pauses as the market consolidates before continuing on its uptrend. 

A Stage 3 market means we want to be more cautious than normal.  We can still buy into new positions on proper breakouts, but we want to take smaller initial positions than we normally would. 

You also might consider taking some profit on your big winners and now is most definitely not the time to give your stocks extra leeway.  If a stop is hit, exit immediately.

Ideally, we’d like to see leading stocks rest up and form new bases in a Stage 3 market.  Entering a Stage 4 is where deeper bases are formed and some stocks crash all together, never to return to their heights. 

The distribution day count now sits at four.  Four or five distribution days in a one-month period often signals that the market is heading into correction mode.  Therefore, if we see another distribution day this week, we’ll want to put our money to work on the short side. 

The simplest way to profit from a market correction is explained thoroughly in the current issue of Darvas Trader PRO, which you can download right here.

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