After the horrific Paris terrorist attack on Friday, November 13, many investor, traders, and analysts expected markets to fall sharply. Sure enough, when the futures opened for trading that Sunday evening, we saw prices drop – but they managed to recover and open positively Monday morning. That “buy the dip” opportunity was followed by a swift upward trajectory, which led to a massive rally and set the pace for the rest of the week. In fact, the stock market enjoyed its best weekly performance of 2015, with the SPX 500 rising more than 3.3%. With all the turmoil, uncertainty, and negative expectations, it was truly an amazing feat.
Last week’s market behavior proved once again how hard it is to predict what will happen; markets simply do not have the emotional response of humans. However, patterns and trends are powerful tools, and if we let them guide us, we can see the opportunity to buy the dip – an opportunity that many miss.
On that fateful Friday, markets were off again sharply for the third time in a week and down six out of seven trading days. Several metrics pointed out that markets were oversold and had dropped about 3.5%. The last dip of that size was in mid-to-late September and that followed the massive market drop in late August. Every dip is met with a skeptical eye – is this the one that won’t get bought? – but perhaps it was time to take prices up. Sentiment was starting to sour (a good contrarian indicator), and now it seemed likely that the terrorist attacks would cause more selling. But that did not happen.
Historically, stock market drops that follow tragic events are often great buying opportunities. After other terrorist attacks – the London train and bus bombings, the Madrid bombing, airliner explosions, the attacks at Charlie Hebdo in Paris, and even 9/11 – saw markets move sharply lower but then recover ferociously. If you can keep your cool and remain patient, the short term price drop becomes a huge buying opportunity.
In the short term, most people invest and trade with an emotional bias, letting fear or greed get the best of them. A steady hand and focus on the bigger picture is often rewarded in these situations. Those who may have sold during the dip and did not return to buy now find themselves behind the eight ball after a strong week, perhaps asking themselves, “How and when do I get back in?”
The pattern of 2015 has been to buy dips and sell rips. Keep following the pattern until it changes.