It seems that when sentiment gets one-sided and markets enter a phase when there is little or no reversion to the mean the usual result is an unusally large collapse in prices. That has certaintly been the case this last week. There have been many fingers pointed at the cause. The most notable finger pointed is actually that of a fat finger hitting the wrong button. Another is the baby bottom rash causing a drop in PG and bids being withdrawn from those very market makers that are supposed to create liquidity in the markets. Of course Greece is being blamed, and at least there is some plausibility and cause for concern there. Perhaps the most realistic cause is that every one ran for the exits at the same time due to an extremely overextended and one-sided market with almost no self-correcting action during its long bull run. I’ve warned that an unexpected drop during these conditions could happen at any moment, with the least little trigger, and without much warning from technical indicators.
Regarding sentiment, it seems that bears either disappeared or were unusually silent during the last part of the upmove. I even heard some seasoned trader who should know better say that maybe there is no more downside to the market. That this time is indeed different. Whenever you hear “this time is different” it is time to start looking at the opposite side of the trade. This time has never been different for as long as I can remember.
Regarding the technical condition of the market, which this blog is about despite my digressions, the trend has certainly quickly changed from up to down. It is easy to hunt indicators after the fact to try to find something that gave advanced warning of this drop. I’ve been getting many such emails from chat rooms that claim to have predicted this. I didn’t get any of those emails prior to the drop, only after the fact. I’ve been showing the same trend indicators, which are those blue lines over the price bars. The lines crossed over to the bearish side on May 4th. The adaptive CCI in the sub-graph actually crossed under the plus 100 line on April 27th warning that the trendiness of the market was waning. Not a sell signal by itself in my opinion, but a good yellow light. As long as the trend indicators remain bearish I expect to sell rallies. When markets make multi-standard deviation moves like we’ve seen over the last couple of sessions it is probably best to let things settle down a bit. There could certainly be a big bounce back up to those moving averages. But there was much damage done, and despite the bullishness regarding recovery and improving earnings, the backdrop is far from bullish in my opinion. I think the market finally got a good dose of reality and I suspect there is much more to come.
I’ve had a long time fear of electronic markets. I don’t think computers should be allowed to replace humans. I know it is happening very quickly. The end of trading pits and posts are fast approaching. But I think it is a very bad idea. So call me old-fashioned.