Stocks are selling off as the political gridlock in DC rages on. We are clearly under the 50dma and broke recent lows, triggering a new wave of stop-loss selling. The next level of support is back at the August lows.
Tentative bulls hoping to profit from a quick resolution pop are getting chased out as the fear of a default increases with each day. Traders are not selling because they think these negotiations will end in calamity since most rationally recognize we will put this speedbump behind us in a matter of weeks. They are selling because they fear the market will collapse under their feet and are trying to get out first. The problem with emotional selling like this is they are giving discounts to more bold traders willing to hold through this uncertainty.
While it is no fun to see a position lose money, we need to look past the headlines and see what comes next. While a default seems unlikely, a more realistic outcome is another US debt downgrade. In 2011 the S&P downgrade lead to a sizable selloff and is what bears expect here, but back then we didn’t understand the consequences of the S&P downgrade. Having lived through it, most realize the downgrade was trivial as US Treasuries actually increased in value. Markets fear the unknown and when it comes to ratings agencies opinions on US debt, we now know they don’t mean a whole lot.
Some big money traders are trimming their positions as the market comes in, but others are looking to buy their favorite stocks at a discount. There was little reason for big money to chase stocks near all-time highs given the headline uncertainty, but now that prices have dipped to more attractive levels, longer-viewed investors are starting to buy the dip.
Expect volatility to persist until the political gridlock is behind us. The best trades are often the hardest to make and the more this market sells off, the more profit opportunity it gives us. We are traders and should embrace volatility, not fear it. The August selloff ended with a swift plunge under the 50dma and today could also be a similar capitulation point. Don’t expect a sharp rebound, and we can wait for the market to find support before making any news buys.
Most expect our politicians will push us to the brink, but not go over. While that means most holders anticipated this volatility and are unphased by it, what is not priced in is an actual default. We’ve seen credit downgrades before, but an actual default is uncharted territory and the market will sell off hard if our politicians take us there.
The lower we go, the more upside the rebound has. It is not wrong for a longer viewed investor to own in anticipation of the expected resolution, but adjust your position size to account for the increased volatility and risk. And of course there is no reason to have a position on at all. The best trades are when the wind is at our back and this choppy market is a tough place for both bulls and bears. We have at least another week of this political gridlock in front of us and expect the volatility to persist.
Plan your trade; trade your plan
Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, 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 children.