Posts filed under “Trading”

Guide to Stock Market Corrections

 

The S&P 500 hit 1709 a few weeks back and has since been dropping precipitously, we are now down roughly 3.7% from that level in a short period of time. Heading into today, we’ve been negative 4 days straight and have seen losses during 9 of the last 11 days on both the S&P 500 and the Dow Jones Industrial Average.

Suddenly, everyone is talking about this being a correction. I would say that at the current moment, we are just barely in a dip but possibly headed toward a correction. Let’s first define some terms:

 

correction

 

With a market pause that is not yet even a 5% dip – let alone a 10%+ correction – people (myself included) have been jumping the gun in trotting out the C-word so early.

But for argument’s sake, let’s say we’re headed for a real correction…what should we expect? Today I’ll limit my remarks to price action and not get started into a whole discussion about news, valuations, or anything else.

A handy field guide to stock market corrections below (data via Dow Jones, Morningstar, Bloomberg):

* Since the end of World War II (1945), there have been 27 corrections of 10% or more, 12 of which had turned into full-blown bear markets (with losses of 20% +).

* This equates to one correction roughly every 20 months, according to Dow Jones index maven John Prestbo, who points out that this average does not mean they’re evenly spaced out. 25% of these corrections over the last 66 years occurred during the 1970′s (the Golden Age of Market Timers), another 20% occurred during the secular bear market of 2000-2010.

* The average decline during these 27 episodes has been 13.3% and they’ve taken an average of 71 days to play out (just over three months).

* From the beginning of the last secular bull market in 1982 through the 1987 crash, there was just one correction of 10% or more. Between the Crash of 1987 and the secular bull market’s peak in March 2000, there were just two corrections, according to Ed Yardeni. This means that secular bull markets can run for a long time without a lot of drama.

* Since the stock market’s bottom in March of 2009, there have been only 3 corrections: In the spring of 2010 the S&P 500 began a 69-day drop of roughly 16%. The widely referenced summer correction of 2011 lasted for about 154 days and almost became a bear market. The correction during the spring of 2012 set up one of the greatest rallies of all time, although it was barely a real correction, sporting a peak-to-trough drop of just 9.9% in just under 60 days.

* The most recent correction took place in 2011, between the end of April into the end of September. The Dow dropped roughly 16%. The S&P 500 actually dropped a hair over 20% before snapping back, leading some to believe that this was a bear market – the implication being that the current bull market is just 2 years old and not five years old (dating from March of 2009). I have no strong opinion on that debate.

* Bull market rallies in between corrections – and there have been 58 in the post-war period – tend to run for an average of 221 trading days before being interrupted and gaining an average of 32%. By this standard, we are way overdue for a correction (but in fairness, we have been for awhile).

* As to what we should do during corrections, I’d recommend maintaining a list of high-quality stocks you’ve been kicking yourself for missing out on and clearing the decks of any longs you don’t truly love. For those with time horizons longer than five years (most), the best thing to do is grit one’s teeth and do very little. If a correction of between 10 and 20% is unbearable to you mentally or financially, that means you’ve  either got more money than you should invested in stocks or you’re kind of a fairy. Make the adjustment you can live with and remember this feeling the next time you find yourself chasing the market.

* As to the question of whether a correction could become a bear market (or worse even, a crash), the answer is that this is always possible. But most corrections do not become crashes, and every single one of them turned out to have been great buying opportunities in the fullness of time.

* Lastly, remember your ABC’s: Always Be Cool.

Category: Cycles, Investing, Trading

The Art of Intuition and the Science of Discovery

“The intuitive mind is a sacred gift and the rational mind is a faithful servant. We have created a society that honors the servant and has forgotten the gift.” ~ Albert Einstein What is intuition and how might it help or hinder an investor’s decision making process? A good philosopher begins with definitions, otherwise they…Read More

Category: Philosophy, Psychology, Trading

Buffett’s Exxon Bungle

How often do you make a decision to sell something for a giant gain? Quite a few times across the arc of a career, if you are a half-decent investor. But how often is that sell decision a terrible mistake? Today, I want to tell the tale of Warren Buffett’s bungled profit-taking in Exxon. We…Read More

Category: Investing, Trading

A Few Words About Valuation

A few weeks ago, Yale Professor Robert Shiller won the Nobel prize for his work on irrationality and inefficiency of markets. Since then, we have been treated to a plethora of stories on some of his other work — especially so-called CAPE, Shiller’s measure of long term valuation. The general consensus seems to be that…Read More

Category: Investing, Trading, Valuation

DAX Flash Crash 2 (17-Apr-2013)

Click to enlarge Source: Nanex

Category: Digital Media, Trading

Quote Blast Loops May Have Caused Nasdaq Freeze

Nanex did some digging into market data before the Nasdaq blackout at 12:20 EDT on August 22, 2013. They discovered several significant periods of extremely high quote volume. By plotting the number of messages for each of the 6 multicast lines used by the Tape C SIP (Securities Information Processor), we discovered the quote blasts map directly to individual multicast lines.

Note that this is the data feed that Nasdaq claimed as the source of he bad data.

 

Click to enlarge
Chart

 

From Nanex:

“The first chart above plots the number of messages for each multicast line between 10:50 and 12:10 EDT. Note there are several message surges: each of which is confined to an individual multicast lines (single color). The surge on line #6 at 10:55 (red line) is from zeroed bids and asks from ARCA (this is detailed in another chart below). The 3 surges at 11:48 (blue), 11:50 (red) and 11:54 (green) are actually from a resending of the previous 50 minutes worth of quotes as if they were new quotes. Each quote had a new timestamp and marked as if it were real-time – which caused these quotes to update the NBBO! We detail this in the stock ORLY in 2 below.”

We are slowly destroying the core structure of our capital markets.

 

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Category: Really, really bad calls, Think Tank, Trading

Aykroyd: Let Me Explain the End of ‘Trading Places’

We previously discussed what actually happens at the end of Trading Places (July 20th, 2013). As a follow up, Businessweek cornered legendary actor, comedian and entrepreneur Dan Aykroyd to find out why “Trading Places” is the greatest business movie of all time.   Bloomberg, August 6 2013

Category: Film, Trading, Weekend

HFT’s Unfair Trading Advantage / Front Running

Wherever you see red in the charts below, that’s when HFT received an unfair trading advantage and front ran other traders and investors.   Click through, scroll down a bit, then hit start for samples of HFT front running Source: Nanex   Nanex observes that: “Each chart plots trades and quote spreads from Nasdaq and…Read More

Category: Legal, Really, really bad calls, Regulation, Trading

Institutional Investors Don’t Trust the Exchanges

Exchanges Live In Glass Houses Joe Saluzzi, Sal Arnuk Themis Trading, July 2, 2013       The head of US Market Regulation for Nasdaq, John Zecca, just published a one page article titled “A Level Playing Field For Surveillance” . In his article, Mr.  Zecca is calling for increased surveillance of dark pools.   Specifically, Mr….Read More

Category: Really, really bad calls, Think Tank, Trading

Japan versus Gold?

Charts like this make me want to Sell Japan and Buy Gold — at least for a quarter or so.   click for larger chart Source: Josh Brown

Category: Contrary Indicators, Technical Analysis, Trading