Stocks shattered 1,770 support and tested 1,750 in early trade. They are at three-month lows and trading at levels not seen since early November.
The market had been chopping around since finding support following the Emerging Market selloff, but took a fresh leg lower this morning on weaker than expected PMI. This violated widely followed support levels stretching back to November, triggering a wave of automatic stop-loss selling.
Like every market move, there are always two possible outcomes. Either this weakness is an overreaction and we bounce back, or this hints at more selling to come. It’s not surprising to see the market dip under 1,770. Market makers, brokers, and HFTs make their living on trading volume. If markets slip under support levels, it sends off an avalanche of trading and these guys can make next month’s alimony payments. The big question is what happens after we fall under support. Does this stop-loss selling exhaust itself as we run out of supply? Or does weakness shake the resolve of previously confident owners, leading to a fresh round of emotional selling?
By midday, most of the automatic stop-loss selling already occurred, leaving many owners dominated by fear and indecision. This is a classic “pain trade” and clearly it is having the intended effect. Two weeks ago we were too bullish and it is hard to say the same about this market. So far this weakness is shaking free short-term traders and late rally chasers, but for most of the buy-and-hold crowd, this is just another opportunity to load up on stocks at better prices. There are only so many nervous sellers that can be shaken free. As long as the slow but steady recovery in the US continues, we are likely near the end of the selling.
If the market is shifting to a half-empty outlook on the economy and fragile recovery, look for a dramatic re-pricing of stocks as prior enthusiasm gives way to widespread pessimism. Every dip presents a buying opportunity, it is simply a matter of waiting for the right opportunity to get in. If the market continues obsessing about negative headlines, then we are not at that point yet.
Long-term holders should continue holding because that is what long-term holders do. Short-term traders can get more aggressive with this dip. With most of the stop-losses already triggered, bears and short-sellers need emotional selling to accelerate. More bad news will likely push nervous owners over the edge. On the other side, dip buyers will have a strong tailwind if a little bit of good news triggers a short squeeze. After 1750, the next likely level is the 50dma.
Plan your trade; trade your plan
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.