PM: The Plunge

By Jani Ziedins | End of Day Analysis

Feb 25
S&P500 daily at end of day

S&P500 daily at end of day

PM Update

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?

MARKET BEHAVIOR

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.

MARKET SENTIMENT

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.

TRADING OPPORTUNITIES

Expected Outcome:
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.

Alternate Outcome:
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.

INDIVIDUAL STOCKS

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.

Stay safe

 

Follow

About the Author

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.

Jonathan February 25, 2013

Let see what the market does tomorrow. The last hour of trading was downright scary when the market got hammered. I am thinking we are more likely to test 1475 then we are going to retest 1530. We will eventually get to 1530 but probably not until this selling stops.

Jon February 25, 2013

Hey Jani,

Been meaning to ask in your previous posts, when you mention “automatic stop losses,” are you generally referencing stop loss sell orders for “retail investors” or larger institutional automatic selling?

Rob Butta February 25, 2013

Thank You for your Market Update.
Would like to know your view on the two following major items that occurred today, that will no doubt dampen the spirits of would-be Buyers at this juncture:
. 30Yr Bonds Futures (/ZB) rallying straight up on heavy volume pretty much from the get go of the Cash Markets Open.
. VIX jumping from 14 to 19 in just one trading session !

AS a side note, I have learnt that there was some heavy betting for a VIX increase lately with some unidentified institution buying 50,000+ March 15 VIX Call Options in the VIX Futures Pit on wednesday afternoon, just before the FED’s Minutes came out, clearly anticipating a significant correction in the Equity Markets in the next few days/weeks, that would create an equally significant spike in the VIX. (Source: Jon Najarian, OptionMonster)

    Jani Ziedins February 26, 2013

    Europe is becoming a less safe place to keep money and that is boosting the value of the US$ and Treasuries. The VIX is often a trailing indicator and only spiked after the selloff was well underway. Looking at a daily chart says the same thing, the VIX just puts a number on it.

    Just to clarify, I expect a normal pullback over the medium-term, I’m just looking for a double-top or head-and-shoulders first, meaning this first dip will bounce back to new highs before we roll over.

      Rob February 27, 2013

      Hi Jani,
      Many Thanks for taking the time to reply to my query. I concur with you about the US markets being the preferred destination for Equities and Bond investors at this juncture, which bodes well for these markets, despite all of the negative headlines about anaemic growth, sequestration, and debt ceiling issue.
      Take Care

        Jani Ziedins February 27, 2013

        From adversity comes opportunity. Markets rally in the face of fear and fall on the back of complacency.

Kevin February 26, 2013

Actually the move yesterday was on high volume, for the dow highest selloff volume in last 2 months, for the SP-500 it was 4th distribution day in last week. Reasons to sell off? All over the place. Big boys have been leaving through back door for weeks

    Jani Ziedins February 26, 2013

    I don’t pay attention to the Dow because it isn’t representative of the broad market. While S&P500 volume was above average, the move was the biggest in 4 months but it didn’t have a similarly impressive volume total. Like everything in the markets this can be bullish or bearish. Bullish in that selling volume is tapering off as we are running out of sellers, bearish because reversals usually happen on huge volume.

    I still think we have new highs in the near future because most often markets reverse in a doubt-top or head-and-shoulders.

Comments are closed