Many traders have been looking for a big drop in the markets, viewing it as an opportunity to get on board. What an awful position to be in, because, as we know, markets are not accommodating. They are going to do what they are going to do, which will only add to the frustration of those who continue to miss out.
The very long-term market trend has always been up (we’re talking since the beginning of markets here); the tricky part is figuring out when to get in. Market timers claim to have an advantage of jumping in and out at exactly the right time, but that strategy has consistently proven to be, well, inconsistent. Market timers will be right sometimes, just like a broken clock is right twice a day.
If you’re on the sidelines waiting, is there really a number that gets you back into the game? Historically, we have seen some big drops of 10-20% that were not good buying opportunities (typically, the bigger number signals the start of a bear market).
Consider this: March 6 marked the five year anniversary of the low point of the SPX following the financial crisis (it sunk to 666 on March 6, 2009). The market’s drop from its peak in less than a year was far, far deeper than 10%. As volatility rose, the market’s precipitous fall became deadly to any trader who dared enter.
How many of you were in the hole by the time the bottom actually occurred? I know many strategists, analysts, experts, and pundits advocated getting in at every drop, beginning in October 2008 and going right through to March 2009. First the market was down 10%, then it was down 20%, then 30% – you get the picture. At some point they were right, but how far behind do you want to be before that miracle hits?
Today’s markets are at or near all-time highs, and there hasn’t been a correction for months. To me, it seems like we are set up for something big to happen. Since 2011, the best correction we could get was around 6-7%, and that didn’t happen often.
With that said, there has been a pattern of buying 3-5% dips, and that strategy has worked out nicely – SEVERAL times. But if you had said to yourself each time, “This is the big one! I’ll buy down 10% or so,” then you lost an opportunity. On the other hand, if you went short looking for more downside, you got burned – FAST (see the recent recovery from that late January fall into new highs in mid-February). I suspect the next 3-5% drop may be bought up again, but at some point that pattern will fail.
A 10% drop can happen fast, but it would do more damage than anything else, eroding confidence and creating doubt. That confidence is the very thing an aggressive Fed has been shoring up, and fortunately, they have not sacrificed the dollar or buying power to achieve it. When confidence erodes, though, we’ll see a rise in fear (via the VIX), puts being bought with reckless abandon, selling pressure, and protection-buying. A substantial drop in the markets will trigger a frenzy of selling, and not just from retail clients but from institutional investors. We’ll see a significant shift in sentiment, character, market structure and, of course, the chart. For the SPX 500, a 10% drop from here merely gets the index back to 1690, which is where we were just there a month ago – so no harm, right?
Well, not so fast. We’re talking confidence, behavior, and commitment here – all things we pay attention to. Many traders are waiting to jump back in before they see a big drop level out. If there was a pause in the buying, dip buyers who are used to smaller drops would wait. In addition, we pay attention to volume, which is the key to knowing where the money is flowing. If volume starts to rise sharply and consistently, then we’ll know distribution is coming from institutions. In that case, the trend will likely turn down, and that will be an ideal time for finding some short or put plays, as we look for that momentum to continue.
That being said, with any big drop in the markets, I will mostly stand back until the smoke clears, which will likely be further down than 10%! Be careful what you wish for. As I rarely look for tops and bottoms (that is a loser’s game), waiting it out for a rise back up or playing it short for continuation will be my play.