Before you buy the dip, read this article…
Thunder rolled in, the horizon turned an ominous purple, and the wind began to bend the treetops. A few minutes later, the first drops of rain fell.
It came quickly and it went away just as quickly – but this powerful storm left a lot of destruction in its wake.
As you can imagine, when I saw the market crash starting in Japan and spreading to crypto and futures markets, I couldn’t help but feel like the universe was playing tricks on us.
There is no doubt that the stock market is in free fall.
But how long will this storm last?
Before we try to answer that question, let’s review how things happened…
As the yen carry trade collapsed and global recession fears spread, Japan went into meltdown mode. On Monday, the Nikkei fell more than 12%, which the Wall Street Journal noted was the biggest drop since the 1987 crash.
(If you want to learn more about the yen carry trade, please refer to my daily briefing yesterday.)
Of course, the selling didn’t stop there. The bloodbath in Asian markets spilled over into crypto markets and, in turn, into U.S. stocks in the early morning hours. We’ve seen some minor concerns start to surface over the weekend and they began to snowball on Monday morning. You always know the markets are making waves when non-financial types post about the carnage on social media — the panic on Monday was indeed palpable.
Markets are selling off, with the VIX surging to levels not seen since the coronavirus crash. The bell rings, and investors start selling.
These days are testing for traders and investors. How you respond to a major sell-off can affect how your portfolio performs in the coming months. If you are unprepared and start making panicked decisions, this could cause serious damage to your returns.
In a "meltdown" situation, the survivors will be those who are able to stay calm and focused while others panic.
While I can’t tell you how the week will end just yet, we can discuss what to expect in the high volatility environment we’re heading into — and how you should adjust your trading strategies as stocks and major cryptocurrencies enter choppy waters.
When investors are fearful, cash is king
Even in a bull market, the market rarely cares about the great stories of your favorite investments. In a crashing market, you can’t argue with fundamentals or a growth story. If panic conditions set in, investors just want cash. They crave safety above all else.
Cryptocurrency is a perfect example of this phenomenon. I know a lot of people think Bitcoin is a safe haven investment. But the market reacts to the exact opposite! Cryptocurrencies actually trade like risk assets. That's why we saw Bitcoin being pushed down to below 50K on Monday (Sunday EST) as a lot of crypto traders were forced to close their positions. When margin calls come, the only way to pay is cold hard cash!
If investors are raising cash, they will sell anything, even gold. You may remember that gold even plunged a staggering 25% during the crash from August to October 2008. Remember, this was in the middle of a major bull market cycle in gold, which was ruthlessly interrupted by the bankruptcy of Lehman Brothers and the ensuing financial crisis.
Investors also sell their big winners during these times of stress. The VanEck Semiconductor ETF (SMH) is down nearly 30% from its July high. The Nasdaq 100 is down 15% in the same time frame.
Yes, even the impeccable "Magnificent Seven" stocks are collectively down more than 20% from their all-time highs.
Stocks/cryptocurrencies go hand in hand in falling market
During pullbacks and panic events, markets become highly correlated.
what does that mean?
Simply put, during massive down days and crashes, most sectors and asset classes react similarly.
In a bull market, correlations are lower. You see big winners, middle names, and laggards. Think about how the market performed earlier this year. Semiconductor stocks were leading the way, many tech stocks were also rising (although not as much), and other sectors lagged.
This doesn't happen in a sustained correction. When everyone is rushing to the exits, few sectors are immune to sellers. I would say that in this sell-off, most prominent stocks fall about as much as average, while stocks that have gained more in the past few months will be hit harder.
When sentiment sours and investors become more cautious and defensive, it becomes more difficult for individual sectors to outperform the market.
Respect volatility
When markets suddenly become unstable, you may feel a strong urge to take action and do something to stabilize the situation.
But part of investing or trading is simply surviving. After all, you have to preserve your capital if you want to stay in the game! Since we just experienced wild volatility, it’s important to remember that we may see even bigger swings up and down in this new environment.
Volatility can be your best friend or your worst enemy. If you are a long-term investor, then you have a good chance of starting to gradually buy into some of the companies you like.
If you are a trader, you will want to shorten the time frame. You can take advantage of bigger moves. But you need to take profits at the right time because the market is more likely to go through repeated swings.
As for the idea of finding the absolute bottom after a market decline, remember the words of legendary technical analyst Walter Deamer: "When it's time to buy, you don't want to buy."