What does 'Whipsaw' mean

Whipsaw is a condition in which a security's price heads in one direction, but is followed quickly by a movement in the opposite direction. There are two types of whipsaw patterns, with the first involving an upward movement in a share price, which is then followed by a drastic downward move, causing the share's price to fall relative to its original position. The second type occurs when a share price drops in value for a short while, and then suddenly surges upward toward a positive gain, relative to the stock's original position.

BREAKING DOWN 'Whipsaw'

The origins of term Whipsaw derives from the push and pull action used by lumberjacks to cut wood with a type of saw of the same name. A trader is considered to be "whipsawed" when the price of a security he just invested in abruptly moves in the opposite direction of what was expected. As one would surmise, whipsaw patterns most notably occur in a volatile market in which price fluctuations are unpredictable.

The act of getting whipsawed is most common for day traders or other short-term investors. Those who have a long-term, buy-and-hold approach to investing are often able to ride the volatility of the market and come out on the other side with positive gains.

Two Examples of a Whipsaw

The first example of a whipsaw is also the most likely to occur. When an investor goes long on a stock, he buys it with the expectation that it will increase in value over time. However, there are many occasions in which an investor purchases shares of a company at the top of a market rally. For example, an investor may purchase a stock at its peak, assuming that it will continue to post big gains. Almost immediately after purchasing, the company comes out with a quarterly report that shakes investor confidence and causes the stock to decline in value by more than 10%, never to recover. The investor is holding the stock at a loss, with no way of getting out, effectively whipsawed.

Conversely, some investors, specifically those who short-sell, can face a whipsaw at the bottom of a market. For example, an investor may see the economy headed for a downturn and purchases put options on the S&P 500. He'll profit if the market continues to decline. However, almost immediately after purchasing the put options, the market unexpectedly rallies and his options quickly become "out of the money," or worthless. In this case, the whipsaw occurs during a recovery phase, and the investor loses his investment.

RELATED TERMS
  1. Short (or Short Position)

    A short position is the sale of a borrowed security, commodity ...
  2. Equity Derivative

    A derivative instrument with underlying assets based on equity ...
  3. Protective Put

    A risk-management strategy that investors can use to guard against ...
  4. Put

    An option contract giving the owner the right, but not the obligation, ...
  5. Long Put

    An options strategy in which a put option is purchased as a speculative ...
  6. Cash Trigger

    A condition that triggers an investor to make a trade or take ...
Related Articles
  1. Trading

    Look At The Whole Picture To Manage Whipsaws

    Look at past action to organize a whipsaw’s volatile characteristics, identifying harmonic levels that may offer low risk entry prices.
  2. Trading

    How To Cover Your Bases After Making A Trade

    Follow up your trade entry with these time-tested risk management strategies.
  3. Trading

    Stock Price Outlook for Alphabet (GOOGL)

    Google stock is in a very interesting location on the price chart. Here are scenarios for short-term and potentially longer-term trades.
  4. Trading

    Capitalize On False Breakouts In The Danger Zone

    Sometimes you have to be a predator to profit. Find out how to cash in on false breakouts.
  5. Financial Advisor

    Value Investing Strategies in a Volatile Market

    Volatile markets are a scary time for uneducated investors, but value investors use volatile periods as an opportunity to buy stocks at a discount.
  6. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
  7. Investing

    Volatile Stocks: Great, If You Have The Stomach

    Volatile stocks can be a lucrative opportunity for short-term traders. For buy-and-hold investors, it's a much different story.
  8. Investing

    Master Futures Trading With Trend-Following Indicators

    The futures market is a lot less scary when these indicators are used to establish current trends.
  9. Trading

    The Roles Of Traders And Investors In The Marketplace

    Discover how these two groups work together to keep the market functioning properly.
RELATED FAQS
  1. What are the main advantages and disadvantages of using a Simple Moving Average (SMA)?

    Examine some of the potential advantages and disadvantages involved with the use of a simple moving average or an exponential ... Read Answer >>
  2. If I believe retail sector companies are overvalued how can I profit from a fall ...

    Examine the various trading strategies that can be employed by an investor who anticipates a decline in stock prices in the ... Read Answer >>
  3. What are the best technical indicators to complement the Vortex Indicator (VI)?

    Investigate possible complementary indicators to use along with the vortex indicator, including chart pattern recognition ... Read Answer >>
  4. How can I profit from a fall in stock prices of companies in the financial services ...

    Learn about the different methods successful investors use to profit by trading in the financial services sector, even when ... Read Answer >>
  5. What's the difference between a long and short position in the market?

    Understand long and short positions for stocks and option contracts; combine long and short positions for added leverage ... Read Answer >>
  6. How can an investor profit from a fall in the utilities sector?

    Learn how an investor can profit from a fall in the utilities sector by employing speculation methods such as short selling ... Read Answer >>
Hot Definitions
  1. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  2. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  3. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  4. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  5. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  6. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
Trading Center