How To Know How Low Is Low

We are now well into the market selloff that started just a little over a week ago in mid February and the body count is still rising.  Stocks that had shown relative weakness have continued their descent, but now even heretofore strong stocks are joining in the selling.  There are technical reasons for this that have nothing to do with underlying fundamentals.  We can probably agree that a business doesn’t go from lucrative to disastrous in one week.  The selloff has to do with the mechanics of how money managers and traders work, specifically, the employment of sell stops and asset management protocols in their mandates.  The chart below shows the actions of Visa (V). While there were warning signs as shown by the divergence of key momentum measures leading up the new high in February, the mechanics of money management likely amplified the selloff in the context of the overall markets.

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Remember that stock prices discount future events, at least with what’s known, but that doesn’t mean that emotions don’t play into pricing.  Not all market movements are rational.  As much as too much optimism can be priced into a market, so can too much pessimism drive it lower.  The reason that prices fall quicker than they rise is that fear is a big motivating factor.

Having the objectivity of market tools to ascertain peak momentum in buying and in selling allows traders to objectively assess opportunities.  No one knows when a selloff will wring itself out, but as we observe activity from day to day, measures of market momentum will gradually shift to create possible opportunities.  As stated before numerous times, it’s most important to be confident that there is evidence that the overall environment is supportive before deploying capital.  The best indicators are the conditions of the overall stock indices.  If downside momentum slows and especially if it’s in tandem with historic levels of price support, we can use tools to fine tune possible entry points.

To be clear, just because an issue sells off at some nominal percentage, there is no guarantee that it can’t fall further.  Just ask anyone bottom picking recent market darling Tilray (TLRY) which has fallen from 178 to 14.   Any bottom picking should come with a sober analysis of risk even as we use technical tools for entry.  In stock market history, a 5 standard deviation move is considered somewhat rare and therefore creates an opportunity.  But during the 1987 stock market crash, there were 30 standard deviation swings, so there is no absolute. A 2016 article by Max Koppenheffer illustrates this phenomenon.

In summary, we look for slowing of downside momentum, using a ROC tool, we look for areas of support, either via previous levels, or by fibonacci projection and then zero in using specific candle patterns to minimize entry risk as much as possible.  As to specific stocks, we would look at the bigger liquid Dow type stocks first. As basing happens, other issues will follow and we determine this by doing sector comparisons the drill down into the relative strength issues.  Rather than approaching markets fearfully, these big sigma swings are opportunities for those appropriately prepared.

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