What is Whipsaw?

Even those with basic knowledge of stock markets know that they can be volatile. Analysts and researchers have developed various strategies and tools to deal with volatility in the stock market. Advanced analytical and charting tools can help predict the market's movements. But, there are no perfect tools and markets can be too complex to make precise predictions. Sometimes share prices can move in an opposite direction to what you expect. A whipsaw is a sudden change in price direction.

What's whipsaw, you ask?

Do you remember seeing a lumberjack cutting down a tree? You can search for lumberjack videos on any video streaming service. To fell trees, they push and pull a saw continuously. The saw is moved in opposite directions to cut the tree. The action of lumberjacks is what gave rise to the term whipsaw in stock exchange. If the price of security moves abruptly in an opposite direction to what the trader expects, it is called whipsawing. In volatile markets, whipsaw patterns can often be observed. When the market direction suddenly changes, day traders and short-term traders often get whipsawed. Whipsaw patterns are less likely to affect people with long investment horizons as short-term volatility has no impact on long-term returns.

Let's look at an example to understand whipsaw. Let's say that the share price for XYZ has risen. In the expectation that the price will rise, you take long positions. The momentum suddenly reverses and the price begins to fall. This sudden reversal can result in either a partial or complete loss of your investment. The same applies to shorting. If the price of XYZ shares suddenly rises, you'll lose.

Can whipsaws be avoided?

Whipsaw refers to a sudden shift in the direction of security prices. Whipsaw can be avoided by anticipating the sudden shift in asset prices. It is not easy to predict whipsaw's sudden price changes. There are some things you can do to avoid being caught in a whipsaw. Before taking on new positions, you should conduct thorough technical and fundamental analyses. Analyzing a stock will reveal if it is in the overbought territory or undersold. Stocks that are overbought may see a sudden decline in price and vice versa. Avoid whipsawing by being careful when taking long positions in overbought securities or short positions in oversold securities.

How to avoid stock market whipsaw?

Before trading on a new stock market or stocks, do extensive research and analysis to determine the market's needs and create a trading plan. To avoid whipsaw in stock market markets, there are a few steps traders can take.

Demo trading: It is recommended to open a demo account when trading in a new currency. You can create new strategies and conduct independent analysis to determine the trends in a particular market or security. Demo trading accounts offer virtual money, but the same experience as actual trading.

Advanced analysis: You can benefit from advanced technical and fundamental knowledge if you plan to trade intraday or in volatile markets. Fundamental analysis provides a wider view of the supply-demand scenario and other metrics that impact the share price. You can use technical indicators such as the exponential moving average or standard deviation to spot overbought assets and make informed decisions.

Set a stop loss limit When trading in volatile markets, it is important to remember to set a limit. Although it won't prevent losses, a stop-loss will help to limit losses in the case of whipsaw patterns.

Conclusion

You can predict whipsaw patterns in stock markets by analyzing the technical and fundamental indicators in detail. Whipsaws in stock markets are unpredictable and no strategy can be fooled.