It was a dreadful day for the S&P 500. In fact, this nearly 6% loss was the worst day for the index since the depths of the Coronavirus collapse back in March.
There was no definitive headline driving today’s selling. Instead, this was one gigantic tidal wave of second-guessing that hit all at once. Between the struggling economy and signs of a second wave of infections in Asia, many investors slammed on the brakes and those second-thoughts were contagious.
As well as the market has done over the last few months, it is was actually surprising it took this long for stocks to take a meaningful step-back. But as I’ve been writing, investors have largely been ignoring headlines and this remains an emotionally driven market. Those blinders propelled us on the way higher and this group-think contributed to today’s simultaneous, mega-collapse.
But as bad as today felt, did anything change? No. The economy is still in shambles and a second wave of infections is inevitable. All things we knew yesterday and none of this is new to anyone. If these things didn’t matter before, then it probably doesn’t matter now. Stocks made a huge run since the March lows despite these fears and periodic waves of profit-taking like this are inevitable.
But just as important to this market is the nearly unlimited amount of money and resources governments are throwing at this problem. If we learned anything over the last decade, it’s that stocks absolutely love free money and by that metric, the good times are still rolling. The free money is flowing out of control and despite today’s temporary dip, expect those unprecedented flows to keep propping up stock prices.
This pullback was long overdue, but this was just a normal and healthy step-back on our way back to all-time highs. This is not the start of some much bigger collapse. Expect this selloff to bounce like every dip that came before it this spring. If the bounce doesn’t occur Friday, then look for it early next week.
But just because this market will bounce doesn’t mean we should ride this wave lower. Every responsible trader uses stops to protect themselves in case they are wrong. Earlier this week I suggested last Thursday’s close was a good level for a trailing stop. We undercut that level early in the day and that was our signal to get out no matter what we thought was going to happen next.
Now that savvy traders are in cash, it is time to start looking for the next buying opportunity. If prices bounce tomorrow morning, test that opening strength with a small buy and stop under the early lows. (It doesn’t matter if we open red or green, just which direction the market moves after the open.) If prices rally through the day, keep adding more. If prices finish near the daily highs, hold over the weekend.
On the other end of the spectrum, if prices fall from opening levels tomorrow morning, stay in cash and wait for the bounce. (An aggressive trader can short the weakness, just stay nimble and take profits early and often) As bad as today felt, traders should be excited to see this volatility. As much fun as it was riding this spring’s wave higher, we make a lot more money from this back-and-forth.
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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.