Finally time to buy the dip?

S&P500 daily at end of day

End of Day Analysis

MARKET BEHAVIOR
Stocks sliced through any semblance of support as the selloff continues.  We fell over 80-points from the all-time highs set last Friday.  This includes breaking the 50dma Thursday and continuing lower on Friday.

MARKET SENTIMENT
It is hard for the financial press to come up with a justification for this selloff other than “profit taking”.  There are no fundamental headlines dominating trading rooms and it largely seems like people are selling for no other reason than everyone else is selling.  The high-flyers are taking it the hardest, down 20 and 30%.  Some claim the death of these mo-mo stocks signals the end of this bull run, but here is the thing, markets typically top when the hottest stocks continue higher while everything else drops back.  During the dot-com boom, brick-and-mortar companies were shunned while everyone was piling into speculative internet stocks.  Today we have the opposite.  The momentum darlings are down double digits while the broad market only slipped a few percent.  Is this the end of the bull market?  Not if we use history as a guide.

Stocks fall for only two reasons, waves of selling or lack of demand.  A rush of sell orders is the stereotypical selloff and fairly intuitive.  This is when everyone hits the sell button at the same time and that surge of supply overwhelms demand, crushing prices.  The less intuitive reason prices fall is lack of demand.  This is when most traders still believe in the market, but prices come under pressure because prospective buyers wait patiently for more attractive prices.  

Surges of buying and selling often see volume leap 30 and 40% above average, but over this 80-point slide, the most elevated volume we’ve seen was 8% above average.  That hardly qualifies as a mass exodus.  The lack of huge selling volumes suggests most owners are confidently sitting through this weakness and these price declines are largely driven by lack of demand.  This is important because it gives us insight into where we are headed next.  

TRADING OPPORTUNITIES
Expected Outcome:
There are two kinds of selloffs, those driven by fearful headlines and those that seem to fall for no reason at all.  This week’s selloff  lacks a fundamental catalyst and these mysterious selloffs are primarily caused by supply and demand imbalances.  All of the big selloffs people remember and fear are triggered by a fundamental catalyst that sent shivers of fear through the market.  Contagion, Default, Taper, Sequester, etc.  Confident owners need a boogeyman to shatter their confidence and turn them into sacred sellers.  So far we don’t have a boogeyman and that likely means this selloff will be more shallow since fewer owners will impulsively sell the fear mongering.

Alternate Outcome:
Sometimes we don’t figure out why a market is selling off until after it already happened.  If this market continues collapsing, the financial press will invent a reason.  While today’s selloff stalled just above 1,810, we could see a fresh round of emotional and reactive selling if we breach 1,800 next week.

Trading Plan:
The best profit opportunities are born from the most uncomfortable situations.  Buying the dip Wednesday after holding support was the easy, and wrong, trade.  Buying now that we’ve crashed through support is far more difficult.  And that is what likely makes it the right trade.  Without a fundamental driver, expect this selloff to stall soon.  Shorts should look to take profits and bold dip-buyers can take a chance.

Plan your trade; trade your plan