The US stock market has a long and storied history, where countless fortunes have been made and lost since the late 1700s.

In modern times, the growth of quantitative trading strategies has made statistics an important part of how institutional and retail investors analyze the markets.

Therefore, as modern-day traders we must be able to combine the statistical nature of stock market declines with key technical rules.

I’m about to show you how this practice helped me stay with the trend this week, despite the growing number of indicators warning that conditions may soon become increasingly choppy.

Price dips are a common occurrence and are a healthy part of trend development

Since its COVID crisis low on March 23rd, 2020, the S&P 500 has rallied an incredible 91% to its June 2021 highs.

Along the way, there have been numerous small corrections of < 5%, and only one that exceeded 10%.

Interestingly, the more common corrections of late, those that do not exceed -5%, happen so frequently that they are rarely included in historical studies.

Small corrections of the < -5% variety, like the -2% S&P 500 pullback that occurred from the 15th to the 18th of this month, are an essential part of trend development.

Small corrections of this magnitude should not be trivialized, however, because being over leveraged during one of these episodes could be devastating to a portfolio.

Historically, we can expect to see larger corrections of between -5% and -10% about 3 times/year.

It’s simple stats like these that traders should be aware of.

Why?

Because as we approach the second half of the year, it’s important to know that the S&P 500 has only witnessed one correction that has come close to -5% in 2021 (the -4.4% correction that lasted from mid February through early March).

This would suggest that, statistically, the S&P 500 is vulnerable to digestive swings of this scale.

This does not mean that a correction of this scale has to happen in the next 6 months, it simply means that there is a statically-proven vulnerability that traders must be aware of to help them trade accordingly.

The anatomy of a trend reversal

Trading requires a thick skin.

One of the ways that traders eventually learn how to weather the market’s ups and downs is to be able to recognize when a trend actually undergoes a reversal.

Many novice traders believe that if the price of the stock they are trading simply falls below a trend line there has been a trend reversal.

This simply isn’t the case!

As the diagram below uncovers, an uptrend does not undergo an official reversal lower until price falls below the most recent swing low of the preceding uptrend.

Figure 1

Except for an event like the onset of the COVID-19 pandemic in early 2020, when the global economy was shut down without warning, to see a major market index like the S&P 500 reverse a long-term uptrend without first undergoing a topping process similar to that shown directly above is quite rare.

In other words, most major downturns in the market usually occur after some pattern of topping rotation similar to the one shown above has developed.

Where do we go from here?

Trend trading is an incredibly popular strategy used by both retail and institutional traders because trading with the market trend greatly improves your probability of success.

Throughout the entire post-COVID crisis rally, the strategy of buying the dips has worked out well for many traders.

Yes, there have been instances when the higher trend has transitioned from up to sideways, but these sideways consolidations are essential to the development of long-term uptrends.

Fast forward to today and we’re dealing with a setup that is a bit sensitive.

Specifically, as the bottom study on this next chart shows, while the prevailing uptrend did officially resume when the S&P 500 registered a new closing high on 06/10, there is a noticeable slowdown in upside momentum.

Figure 2

Now, there is a large contingent of traders known as contrarian traders that will use this information to start taking bets against the uptrend.

As trend traders, though, we know that the current uptrend from the early May lows will not officially be reversed until the S&P 500 closes below the most recent swing low of 4164.40 set on 06/18.

Until such a breakdown occurs, trend traders can use the slowing upside momentum as an indication that it is time to keep stops close and refrain from taking on too much bullish leverage.