The biggest down day since early November sent a chill through investors. Was this simply a technical selloff that will recover quickly, or the start of something more sinister?
Dramatic selloff in the markets with an intraday range exceeding 2.25%. This was the biggest drop since the Wednesday following the election. Volume was 15% above average, but lower than the selling volume last Wednesday and Thursday.
The market clearly sliced through support at 1500 and is now just 10-points above the 50dma and the 1475 high from last fall.
There was no legitimate fundamental reason for the selloff today. The financial press is pointing to polling out of Italy, but everyone knows Euro Contagion is the Boy Who Called Wolf. It’s been three-years without a collapse and we will still be talking about an ‘imminent’ collapse next year too.
The real story is sellers selling because everyone else was selling. Herd psychology triggering this stamped plain and simple. The market opened innocently enough, gapping up 0.5%, but quickly ran out of buyers after short-squeeze buying dried up. By late morning it was stair-stepping lower on Euro concerns and the last hour was a mad rush for the exits as prices cratered when buyers failed to show up.
Much of the selling was technically based, especially in the last hour as the market broke substantial support near 1500 and automatic stop-losses triggered a cascading wave of selling. Potential buyers were just as spooked by the selling and chose to wait and see. Without buyers the market fell through a trapdoor.
Where does today’s selloff leave market sentiment and how are people positioned?
The interesting thing is today’s massive move came on relatively light-volume and was the lowest volume of the last three down-days. While the drop was dramatic, the actual level of selling is decreasing and suggests fewer people are bailing out. Today’s big drop had more to do with reluctant buyers than a mad rush of sellers. If selling continues slowing down, that will create a near-term bottom and short covering will bounce the market higher.
This massive plunge from record highs and swelling volatility replaced complacency with fear. Any weak holders likely sold in today’s bloodbath. But if the nervous are running for cover who is buying? Buyers acknowledge the risk of further downside, but think the selling is overdone. These new buyers are far more comfortable holding volatility and their resolve will give us more stability going forward. Of course ‘more’ is a relative term and while volatility will continue, don’t expect another selloff of today’s magnitude in the near future.
Clearly my call to buy the 1500 dip last week was premature and as I often say, early is the same thing as wrong. Further, I might not even be early if the market continues selling off, but that is what stop-losses are for. We identified 1505 as a valid entry and 1495 as the bailout. While the trade worked beautifully until 10am this morning, the stop-loss got us out for a modest loss this afternoon. As we discussed last week, a dip under 1500 was a realistic outcome and that made 1475 the next logical level for support.
There is no reason for the average investor to be playing these dips because it is too easy to get run over by the herd. But if someone wants to trade the expected rebound, wait for the market to regain 1500 and use 1495 as a stop-loss. The upside is a new high above 1530 and will most likely continuing past 1540. 5-points of risk for a 30-point gain is a very favorable risk/reward. Waiting for the market to recover a key technical level avoids the risk of catching a falling knife and leaves a trader on the sidelines if the market continues breaking down.
If the expected outcome is a buyable dip, the alternative is a crash through 1475, breaking 1450, then 14245, and finally 1400. Expect a technical bounce at 1475, but if the market cannot regain 1500, look for more downside and that is where the short should be put on. Don’t short this market here, wait for the bounce.
NFLX held up surprisingly well relative to the rest of the market. Its 0.3% loss is practically an up day when the indexes lose 1.8%.
AAPL actually didn’t do too bad, simply mirroring the indexes 1.8% loss. The thing to watch is if it recovers when the market recovers or if it continues ratcheting lower.
AMZN failed to hold the 50dma. High beta-stocks like AMZN rarely work when the market is falling apart and is why understanding what the broad market is key part of trading individual stocks. If the market bounces back, look for AMZN to follow.
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.