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When you notice momentum in the stock market or a particular stock, is it too late to jump in? Here’s one way you can take a step back and look at the market as a whole to avoid being trapped.

A stock that you have been watching has seemingly gone straight up with no end in sight. It caught your attention, as it did that of many other investors, after the second full week of its parabolic run. You keep watching as it goes up for another week while you tell yourself, as the “smart” investor you are, “I’ll wait for a pullback and then buy in for the next parabolic run that will surely be coming.”

But at the end of the third week, you see the stock weakening. The pullback lasts about a week, and then you think, “Here’s my chance!” You jump into the stock on the pullback. The stock goes up for another week, but not quite as strongly as you had expected that it would. But it doesn’t matter, because you are so proud that you are now making money.

Then you wake up one morning, and the stock has dropped 10% in price. You convince yourself it is just a small setback. The parabolic rally will surely resume at any time now.

The stock meanders over the next few days. You maintain your position, waiting for that rally to continue. The week after that, the stock gaps down another 10%. The stock has now moved below the point at which you bought the stock. But your ego will not allow you to sell it. “It will come back. It will!” you try to persuade yourself.

FIGURE 1: ELLIOTT WAVE THEORY. Public sentiment and mass psychology move markets in five waves within a primary trend and three waves in a countertrend.

…Continued in the March issue of Technical Analysis ofStocks & Commodities

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