Yesterday I wrote about the long-term view of the market. Shorter-term, the market’s volatility has been insane–700-point drops, 950-point up days, intra-day swings of 5% … it’s hard to get a read on just what is going on. But I looked back on some other market crashes and have formulated a rough road map.
Disclaimer: I never tell the market what to do, and that’s especially true these days, with what we have seen in the market and from world governments. So if the market doesn’t follow the script, I’ll change my mind.
But as best as I can tell, here’s what you can expect to see in the aftermath of a mini- to large crash:
- First, you get an initial rally of anywhere from two to eight days or so. The market usually enjoys a sharp gain for a handful of days, with the worst-performing stocks during the meltdown being the best performers on the rebound.
- Then, just as investors want to jump on board for “fear of missing the boat,” the market usually pulls back for a few days. It doesn’t give up its entire rally–in fact, the market usually remains well above its major low during this pullback. (This time has been a bit more severe than usual.) But the retreat can be sharp, and if you buy in after the first few days of rally action, you can get hurt.
- After that, the market often gyrates higher for a few weeks. The sellers have been mainly exhausted, and pent-up buying pressures push prices higher. Occasionally, you can get an early leading stock hitting a new peak during this phase, but for the most part, the market is still sorting itself out.
- Finally, the market experiences some type of re-test of the initial, major low point; usually this occurs four to 10 weeks after the low. Sometimes the market doesn’t pull back all the way to the low, settling instead a few percent above the low. But it’s extremely rare to see no re-test at all.
Thus, a couple of thoughts.
- First, don’t expect this market to fall through the floor. Last week’s low is likely to stand for at least a few weeks, if not much longer. Maybe this time is different, but I prefer to go with the odds.
- Second, be wary of chasing the market, even if you’re a nimble trader. Sharp upmoves will probably get sold after a couple of days, and the same with sharp pullbacks. So if you’re playing the swings, it might be better to wait for a couple of down days before buying, and vice versa.
- Third, keep the re-test scenario in the back of your mind–it’s easy to forget if the market rallies for a few weeks, but the odds do favor one happening. So getting sucked in late can be harmful.
You don’t have to look very far back to see examples. In fact, we’ve seen two of these patterns play out this year. Take a gander at the chart of the market during the January-April period, as well as the July-September period.
In the first case, the re-test worked but the rally that followed was just a bear market rally–it failed, and we fell to new lows in July. And in the second case, the re-test failed altogether, as we crashed into last week. Yet studying those charts can give you a glimpse into the market’s pattern in the weeks ahead.