Wait for the market to flex

• Posted by DynamicHedge
• on October 7th, 2014

The jobs report temporarily sent the indices roaring, but under the hood the market lacked breadth. Today we gave back -1.5%. The dogma of BTFD appears as solid as ever. There are two timely questions:

1. Is there enough passively allocated money coming into the market to overwhelm sellers making this another “normal” pullback (4-5%)?

2. How does the market trade in the days after it sells off more than -1.5% in a single session? Put another way, what strategy gives you the best odds of not getting run over while you BTFD?

Lots of psychology at play when it comes to corrections and knife catching. The BTFD crowd is confident. Overconfidence can lead to being early and unprepared for more pain making dip buyer easy to shakeout and adding to the selling pressure, deepening the correction.

Let’s look at how the market typically reacts in the subsequent five sessions when the $SPY loses -1.5% or more in a single day.

 

The Alpha Curves are the graphical representation of the most dominant patterns which occur in the chosen dataset. We’ve annotated what appears to be the most obvious area of confluence in the data. The charts clearly indicate over the last three years when the market lost -1.5% or more in a single session it kept selling off for several days afterwards. Yes, it rebounds, but the path is often more important than the destination. The statistics table shows that in the five days post-selloff there is a positive expectancy for dip buyers. In the worst case the market continued to move lower by -4.8%.

The data indicates that selloffs like the one we’ve just experienced are opportunities, but take time and patience to develop fully. If you’re considering catching a knife just know that in the past, it paid off to be patient for at least a few days. If you’re very bearish, the worst case scenario seen in pattern 2 should be your guide.

To see my full analysis (and to change timeframe and parameters for yourself) CLICK HERE. In the top menu click the “exclude anchor date” button and then hit analyze now.

blog comments powered by Disqus