Why the debt downgrade selloff could already be over

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The S&P 500 slipped another quarter percent Thursday, adding to Wednesday’s US debt downgrade selloff.

But as far as selloffs go, Thursday’s decline was fairly benign. The index hit its lowest point early in the morning, and prices were comfortably above those initial levels for the remainder of the session, even getting into the green for a bit.

Lucky for readers, Thursday’s midday bounce wasn’t a surprise:

We traveled this road 12 years ago, the last time US debt was downgraded. That 2011 episode launched a meaningful, multi-month selloff in stocks. Are we in store for the same thing this time? No, probably not.

Novel events trigger fear and uncertainty because no one knows what is going to happen and with nothing to go on, people often fear the worst. But since we’ve already been down this downgrade path, there will be far less uncertainty this time.

Less uncertainty = less anxiety = less impulsive selling

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Runaway selloffs, well…runaway. They crash day after day and don’t look back. Thursday’s price-action was the opposite of runaway selling. The index opened low, and rather than rush for the exits, dip-buyers gobbled up the discounts and bid up prices.

The thing about panicked selloffs is we need panic. Thursday’s constructive trade took a load of pressure off of nervous owners. Another reassuring session like this on Friday and the 2023 US debt downgrade crash is already over.

Savvy traders recognized early Thursday that the next wave of selling wasn’t coming, and rather than argue with the market, they collected profits and got ready for the next trade.

Now, don’t get me wrong, we could definitely fall into another hole of impulsive selling on Friday, but at this point, the odds of that happening are not very good. If owners were going to panic, it should have happened on Thursday. Another flattish session on Friday and most owners will be breathing a sigh of relief since most investors are reluctant to sell their favorite stocks at a discount.

As for how to trade Friday, savvy traders are already in cash and ready to jump on the next trading opportunity. If the aggressive selling returns Friday morning, short that with a stop above Thursday’s close. On the other hand, if prices turn green on Friday, buy the bounce with a stop under Thursday’s lows.

As I wrote earlier in the week, I was positioned for this selloff, and it turned into a great trade with 3x leverage. But if the selloff is already showing signs of bouncing, it is time to collect profits and get ready for what comes next. I don’t care what happens as long as my trading plan keeps me on the right side of the market.

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