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Careful of Getting Sucked into Value Traps!

One of the biggest questions after a correction like we just had is: What to buy on the rebound? Lots of stocks are trying to bounce, but which are more likely to perform the best?

Longer-term charts can help answer the question. Let’s compare two very different corners of the market: The (QQQ) and the (IWM).

barely hit a new 52-week low when the market crashed recently. Its trough of $164.93 matched prices from January 30, 2019.

, on the other hand, fell to its lowest level in more than four years – all the way down to $95.69.

The higher low shows QQQ has more positive investor sentiment.

IWM’s lower low shows just the opposite. Small caps (along with energy) were lagging before the coronavirus. They then fell much more when the market crashed. The moral of the story is that charts work. Never ignore underperformance or a lack of new highs. These simple technical indicators speak volumes about the underlying fundamentals.

Speaking of fundamentals, did you know less than 20 percent of IWM’s portfolio is in the technology sector? It’s overweight industrials, which took a beating when coronavirus shut down the global economy.

QQQ, on the other hand, is officially 44 percent technology. When you include “communication” companies like and , it’s over 50 percent. Throw in (consumer discretionary) and it’s more like 59 percent.

There are two takeaways. First, simple chart patterns like highs and lows tell us a lot about fundamentals. They’re also more fun to read than analyst reports.

Second, just because something’s bouncing a lot doesn’t mean it will keep outperforming. In the case of IWM, the sharp rebound may be little more than a dead-cat bounce.

It might seem counter-intuitive, but often the stocks that fall the least in a correction rise the most after. Disciplined trend followers stick with these patterns to avoid getting sucked into value traps.