Last week was interesting to say the least. We haven’t seen that kind of selling like we did on Friday in a few years. I think many felt shocked by it because they have become numb by the lack of downside volatility in U.S. equities. We’ve been in a well-defined range for the bulk of 2015 and that provided some comfort for some traders. Did they think it would last forever? Come on.
At the end of July I wrote a post, The Greatest Risk of A Market Peak Since 2007. I laid out some of the troubling signs and charts I was seeing in the market. I ended that post by saying that the next step would be for price to ‘respond’. You could argue last week was that response. The Dow is now in “correction” territory and the S&P 500 broke past various previously important levels of support. So now what?
This is what I tweeted last night while many on social media and the major networks were starting to freak out because Asian markets were selling off and U.S. futures had turned red. I could be totally wrong, but it’s one scenario I could see playing out…
Friday’s selling has pushed a lot of market indicators into ‘oversold’ territory and triggered signals that have previously led traders to buy dips. Muscle memory is going to want to take over for mean-reversion traders this week. I’ll be watching to see if they can gain any control.
As I said above, we’ve broken support in the major indices. This is troubling and will cause sell orders to be placed. Weak hands and skittish investors will narrow their investment time horizon from years to minutes. This will likely push prices lower Monday and maybe Tuesday. The discussion will be over China, the Fed, and/or some random piece of economic data. More likely than not we see some whipsawing, possibly some lower lows in price. If we’re lucky maybe a positive divergence will come out of it…. and maybe not, maybe we do just the opposite, I’ll be watching market internals and price action to get a better idea of what’s happening. But from first blush, the selling last Thursday and Friday was too strong to maintain.
So you’re still concerned that we are near a market peak? We’ll lets play that scenario out. If we are (and who am I to say we aren’t?) at a market top then the first order of business would be creating a lower high, meaning a bounce would still be likely to come within the next couple of weeks. The levels of support that have been broken would likely get tested as resistance and fail. That’s what the bears will be looking for. There’s your worst case scenario – a rise in price that fails at prior support.
I’ll leave you with this great quote from Aaron Brown, Risk Manager for AQR Capital Management from a recent interview with Futures Magazine:
“There are 350 trading days until the 2016 elections. Historically, 32% of trading days were more than 10% below the peak of the last 350 days. I have no strong reason to think the next 350 trading days will be significantly different from history in this respect, so I think there’s a 32% chance that the S&P 500 on November 8, 2016 will be more than 10% below its peak from now until then.”
That’s how someone who manages risk looks at the market…. with math and probabilities not emotion.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.