Written by Lance Roberts, Clarity Financial
A couple of weeks ago, in “Winter Approaches“, we discussed the potential of the correction this past week.
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“None of this data means the market is about to crash. What it does mean, is that a correction of 5-10% has become increasingly likely over the next few weeks to two months.
While a 5-10% correction may not seem like much, it will feel much worse due to the high level of complacency by investors currently.”
When markets are pushing extremes, it seems like it is a “no-lose” scenario for investors. It is at those moments when “selling high” becomes opportunistic, but is incredibly hard to do for the “Fear Of Missing Out (FOMO)”
As shown in the chart below, we had suggested a correction back to previous market highs was likely but could extend to the 50-dma. So far, the correction has played out much as we anticipated.
However, while we expect a rally next week, due to the short-term oversold condition of the market, there is a downside risk to the 200-dma, which is another 5% lower from current levels. Such would entail a near 14% decline from the peak, which is well within the historical norms of corrections during any given year.
For now, the market remains trapped.
Trapped Between Resistance And Support
Thursday morning, I posted our 3-minutes video discussing the market’s failure at the 20-dma resistance.
(We publish “3-Minutes” Monday-Thursday. Click here to subscribe to our YouTube channel for email notification of all of our video postings and live-streams.)
The chart below shows much of the same picture as above, but with a few more overlays. You can see the failure of the market at the 20-dma and the support at the 50-dma. What is essential are the upper and lower indicators.
- Both of the upper indicators are currently registering short-term oversold conditions, suggestive of at least a reflexive bounce next week.
- Conversely, both of the lower “sell signals” have been triggered, and as noted in the video, it suggests there is additional selling pressure on stocks currently.
As we note below in our “portfolio positioning” section, this suggests that over the next couple of weeks, investors should use rallies to reduce risk.
Speculators Get Even More Speculative
Another reason for our short-term concern is that you would typically expect a market decline to pull some of the “greed” out of the market. Such was not the case this time, and the drop did little to dent the “enthusiasm” of speculative options traders betting on a one-way ticket to wealth.
“Over the last three trading sessions, more than 1m Tesla calls traded a day, 50% above average over the last 20 days. Close to 2.5m Apple calls traded on average each day during the selloff, roughly double what’s been typical in the last 20 days.” – Bloomberg
The chart below is the 10-day moving average of the “put/call” ratio. While the market peaked, speculators got even more “speculative” on “buying the dip.” Such is akin to doubling down in Las Vegas, it may work for a while, but eventually, the “house always wins.”
Let me be clear. In the very short-term, there is a high probability of a market bounce. That bounce should most likely be sold into as the longer-term dynamics remain overbought, extended, and deviated from norms.
Much of today’s commentary is also in the interview I did on Thursday with our friends over at Peak Prosperity. (There is also some discussion of other market items not covered above.) We discuss the market, portfolio management, risk controls, and why there is potentially still more downside risk to stocks in both the short- and intermediate-term.
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