What Happens Next in the Stock Market?
November 16, 2017 - A Minor Pullback Wouldn't Matter . . . What Happens Next Does By Dr. Van Tharp Trading Education Institute
As I write this article during Wednesday’s premarket hours on November 15, stock markets are down a bit around the globe. Here in the US, stocks are down about 0.5% in premarket trading — which gives us our lowest overnight level in almost three weeks. There’s no significant news and most media outlets are crediting the overnight pullback to weakness in the energy sector with crude oil prices down more than 1%.
With this morning's pullback being somewhat important — given that we’ve had so few drops in recent trading, today’s session will provide us some interesting feedback. Specifically, will the market again push back up during regular trading hours today? I ask that question because in eight of the last nine trading sessions, the S&P 500 has closed higher than it opened. Every minor pullback has been met with buying. This was especially true when the market dipped in early trading on this past Thursday and Tuesday only to recover through the rest of the trading day.
Pullbacks of any significant depth are very far back in our rearview mirror. It’s been so long since we have had a noticeable pullback that we might need a quick refresher. Market analysts call a 10% price drop in the major indexes a market correction. A 20% drop is classified as a bear market. But we haven’t seen anything close to either of those levels recently. The market hasn’t pulled back even as much as 3% in more than a year. Does that sounds like a long time? It is. In fact, this is the longest streak of trading days without a 3% pullback in the history of the S&P 500 — data going back 89 years. Here’s a table above with the data from Pension Partners showing the longest streaks during that time:
This record breaking grinding bull market has spoiled a whole new group of investors and traders to whom a 3% drop will seem huge. Should this happen, we need to remind ourselves about one important point: A 3% pullback would mean absolutely nothing. Seasoned market participants know that pullbacks are just part of the natural market cycle — I like to think of these as the market’s natural breathing. In fact, if we were to get a 3 – 5% pullback, that would pave the way for the market to move higher.
Let’s look at where the important pullback levels land on the current S&P chart:
It’s interesting to note that the 5% and 10% pullback levels fall at or near the bottoms of some of the trading range boxes we have talked about before.
To be clear — a 3% to 5% pullback would be unsurprising and it would tell us very little by itself. More importantly, I want to watch the reaction after any pullback — that will tell us a lot more about what this market intends. If the market rallies back after a modest pullback and then challenges the recently set all-time highs, the grinding bull is still in progress — unabated.
If, on the other hand, a weak rally follows a pullback and that rally fails to get very close to the early November highs, then we have cause to start looking for more concrete signs of a top forming in the market — especially with the weaker breadth that I’ve written about over the last few weeks.
Even if that kind of modestly sized pullback would not surprise me at all, it’s important to keep taking what the market is giving us. I’m not waiting around for the pullback. Second, buying strong stocks on pullbacks is a strategy that just keeps working. I should also note that for a market giving us such shallow pullbacks, we would be prudent to adjust the size of the pullback that we’ll play.
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