March 01, 2007 at 10:05 am | | Comments 8

When Bulls Become Sellers

Tuesday’s big decline did more than just damage the technicals of the market. Not only were uptrends broken and bases in individual stocks completely negated with the high-volume drop, but there was a major shift in the psychology of the bulls.

For more than 7 months now, every single dip has been a good buying opportunity in the market. Lower prices have meant that stocks are on sale, and anyone who forked over some cash to scoop up the bargains was rewarded time after time. This kind of consistent behavior goes a long way toward conditioning traders and investors to buy the dips, and as a result, any pullbacks we have seen during this time have been very shallow.

Then came Tuesday.

Fear was in the air as the day began, and it never did go away. Prices went down like a lead balloon, breaking key technical levels along the way. Whether you watch pivot levels, trend lines, or moving averages, they were each severed with ease for one reason: emotion.

Wide-ranging bars in technical analysis are days which have unusually large trading ranges compared to recent history. Tuesday certainly produced a great number of these on the daily charts, and that is no coincidence. The reason why is that once traders start to see that technical levels aren’t providing adequate support, they get spooked. Emotions run higher and rules are thrown out the window. Support zones are forgotten, and all that starts to matter to those who are holding positions on the long side is getting out. At all cost. As soon as possible.

Bulls who had recently allocated cash to the market and had been sitting on gains all of a sudden in one day found their positions underwater. Green P&L statements provide comfort and confidence, but red P&L statements tend to elevate the blood pressure and raise valid concerns. Add that to the realization that big ugly down days are still possible, and all of a sudden the bulls have ample reason to want to move to the sidelines.

Those same bulls are now much more likely to become sellers into bounces. Will they sell at the first sign of higher prices? Yes, some will. Will some of them try to endure this pullback but eventually capitulate and flee for the safety of cash? Of course.

The point I want to make here is that the motivation of these bulls has changed. Whereas just recently they were concerned that the market might fly to the moon without them, now they realize that the music has at least temporarily stopped and they need a chair to sit in. The fear they have after Tuesday’s big decline is probably going to linger in their minds, and that won’t go away until they make it to the sidelines safely or things start to shape up.

Jeff White
President, The Stock Bandit, Inc.

[tags]Stock Market, Day Trading, Stock Trading, Investing, Swing Trading[/tags]

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  1. Hi Jeff,

    So I had a conversation on another stock blog. The blog owner Dr. Roberts sees an intra-year collapse to 1750 as probable:

    What do you make of that? By the way, I’m one of the bulls who turned into bears during the week as you described. The Friday session confirmed that this correction has legs.

  2. Hey Ram,

    Thanks for your comments. I do see the expanding triangle (or megaphone) pattern shown in the article you linked to, and like you I do believe this correction has legs.

    Technical analysis works better for price projections in the short term in my opinion. A correction down to 1750 would take a number of months, and a correction of that timeframe could entail so many other factors that it is just hard to say. I would be surprised to see a correction carry that far, but for now I do think that rallies will be sold in the coming weeks and that we’ll see lower prices over the next couple of months at least. But I do not yet see this correction developing into something that will shave off an additional 26% off the Nasdaq from current levels.

    I’m in no hurry to buy and want to see this pullback fully materialize before returning to a net-long status, but right now I just think this is the start of a needed correction (there have been none since last summer) which will keep the long-term uptrend intact that began in ’02. A correction to 1750 would return us to the Aug. ’04 low, and I just think it’s too early to see a move playing out to that magnitude.


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