By Dr. Steve Sjuggerud
“Short-term selling exhaustion.” That’s how Jason Goepfert of SentimenTrader.com described the panic selling in the stock market yesterday morning.
Instead of panicking, Jason ran the numbers to find out what could happen from here. He wanted to answer the question: What has happened in the past after we’ve seen mornings like yesterday morning?
The result was surprising.
Stocks were up two weeks later – in every single historical instance.
It wasn’t just a small move, either – the average two-week gain was 5.4%. That’s much higher than 0.5%, which is the typical two-week change in stock prices.
To run his numbers, Jason specifically looked at every instance in which the stock index futures were trading 3% below their previous day’s close. Yesterday morning’s gap down was big. Looking back to 1982, we’ve only seen gaps down this size or larger in 1987, 2001, and 2008.
You may be surprised to hear it, but a big gap down is actually a good thing, as it is a better confirmation of short-term selling exhaustion.
Jason says: “The larger the gap, the more it indicates panic, and the more likely we will see a rebound in prices as fear recedes over the next 2-3 sessions.”
Whenever I see panic in the markets, I want to remove the emotions and look at the historical numbers. While Jason only had 11 instances in the past from which to draw, the weight of the evidence is solid for a short-term rally to start now.
While I happen to agree with Jason, the reality is that neither of us can know what will happen – all we can do is present you with the weight of the evidence.
Since we can’t know for sure what will happen, I strongly urge you to honor your trailing stops. In my True Wealth newsletter we are close to our trailing stops in many positions.
If one of your stocks close below its stop price, then sell the next day. (We do not use intraday changes for our trailing stops, we use closing prices.)
Following your trailing stops ensures that you limit your downside risk. This ensures that you live to fight another day.
To summarize, as Jason’s excellent work shows, there’s a high probability for a solid stock market rally in the short term. Yesterday may have even been the bottom. However, we can’t know for sure, so follow your stops to protect your wealth.