Why stocks could actually rally if Russia invades Ukraine

Free After-Hours Analysis: 

Tuesday was a good session for the S&P 500. A 1.6% gain allowed the index to break a three-day losing streak and reclaim the 200dma and 4,450 support. While one day doesn’t establish a new trend, it was nice to see the market bounce back from the latest bout of selling.

Russia hasn’t invaded Ukraine and that situation is avoiding the worst-case scenario…so far. But the thing to keep in mind regarding this event is markets deal with bad news a lot better than uncertainty. That’s because traders can put a price on bad news and factor it into the market. Unknow outcomes are impossible to quantify and traders tend to let their imagination get the worst of them.

This phenomenon of uncertainty being worse for stocks than bad news is what allows stocks to actually rally once bullets start flying. While no one wants to see that happen, a hot war means we stop debating what could happen and instead focus on the actual impact of the conflict. And in most instances, reality turns out less bad than feared.

And more than just “less bad than feared”, the turnover in ownership leading up to a conflict also helps stabilize prices. Owners that fear these events sell during the build-up and the subsequent buyers demonstrate a willingness to hold this headline environment. Ownership churn eventually gets to the point where all of the fearful owners have gotten out and there is no one left to sell the next round of headlines. And that’s when the bad news is finally priced in.

Are we close to that point? Maybe. Maybe not. But we get closer with each passing day and stocks will bounce long before most people expect. Anyone waiting for the news to improve will be too late. That’s why smart money buys when most people are still afraid.

As I wrote last week:

I took profits Thursday morning and now I’m sitting in cash, waiting for the next bounce. Maybe it happens Monday morning. If so, great, I start buying back in and will add more as the rebound progresses. But if the selloff continues, no big deal, I sit on my hands and wait for the next trading opportunity on Tuesday or Wednesday.

Well, as it turns out, the index bounced in the final hours of Monday’s session, reclaiming 4,400. That late surge of buying was our signal to test the water with a partial position. And Tuesday’s early strength told us to add more. So far so good. Keep a stop near Monday’s close and see where this goes.

If the selling resumes on Wednesday, no big deal, our early positions already have a nice profit cushion and we simply bail out near our purchase price. Small risks from being wrong and large rewards from being right? Sign me up! These are the risk/reward setups we dream of.

And if the selloff resumes, that’s okay too. We get out and try again next time. In fact, the lower we go now, the more money we make buying the next bounce, so I say bring it on. Either way, I’m ready for what comes next. Are you?

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