This column was originally published today at 12:20pm EST on the Bandit Bulletin, my intraday trading diary over at TheStockBandit.com. It’s being republished here as a bonus for TheStockBandit.net readers. For more information on subscribing to TheStockBandit.com, please check out our stock pick service .
Tuesday’s selloff was huge to say the least, as the major indexes posted their worst one-day performance since 2001. Days like that don’t go unnoticed (and shouldn’t), so let’s take a little closer look at why it happened.
Monday night’s news flow was negative, there is no doubt about it. A combination of events including China’s stock market, Iran’s defiance on shutting down their nuclear program, and even an attempt on our Vice President’s life in Afghanistan all set the stage for a downside open on Tuesday morning in the US markets.
But was the poor news flow really the cause of such a big correction, or was it merely a spark that ignited something that had been building up for months?
I am no perma-bear or perma-bull, and that should be perfectly clear here, but the truth is that this market has not corrected since last summer, and corrections are a normal part of how the stock market functions. For nearly 7 months, the major indexes have moved steadily higher, with the only “corrective” phases being some sideways price action that worked off overbought conditions. Sideways price action is merely the digestion of gains, but it only involves very limited profit-taking (otherwise, a selloff would occur).
A correction was needed, and the storm clouds had been building in recent weeks. I am not saying that I saw such a big slide coming, because I didn’t. What I am saying is that the character of the market in recent weeks has shown some obvious reluctance to move higher, and that has been noted in the Bandit Broadcast newsletter, on the Market Conditions page, and of course on the Bandit Bulletin trading blog. The technical conditions have favored the bulls with the high bases that had formed, and yet the bulls couldn’t run things up and exploit their edge. Instead, several failed breakouts were the result, which has necessitated caution with longs in recent weeks. Lately I have raised stops rather aggressively, and have also limited the number of positions held because of the lack of upside traction. The combination of failed breakouts and very limited momentum was a good signal to at least limit our buys, so I’m pleased to have been cautious in that regard.
I’ve said a lot of times how important it is to gauge the character of market moves. That will always be important, whether watching the overall market or individual stocks. It’s hard to stay 100% objective on the market, especially when holding positions, but trying to stay objective will always benefit us as traders. I just can’t stress that enough. Keep close tabs on key levels, watch the chart patterns  carefully, and always always always consider what is motivating buyers and sellers. Momentum is everything in the market, and when one side has everything in their favor to press things and they don’t, it’s probably time to get more cautious and protect capital more than usual.
President, The Stock Bandit, Inc.
[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]