Last week we shared recent market pundit comments warning of an impending market correction — but we also looked at positive macroeconomic data that seems to suggest the U.S. economy is in for its biggest ascension in nearly a century…
So what were these conflicting signals trying to tell traders?
On Monday it seems we got our answer as indexes saw sharp selloffs, with the S&P 500 closing down 0.7% and the Nasdaq Composite closing down 1.9 percent, completing its worst day since March.
By Friday, the price action had grown markedly worse, as the Nasdaq Composite dropped as much as 2.6 percent on the day.
Now this week, as the selloff continues with seemingly no end in sight, questions arise: When will it end? What price is the bottom? And at what point can traders cover their hedges and resume going long?
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Why All the Selling?
Many factors are weighing on traders’ minds right now…
From rising inflation, tapered bond purchases, tax increases to interest rate hikes — an avalanche of negative indicators seems to be appearing all at once.
Although clairvoyant analysts have sounded the alarm for several months, it took recent comments from Janet Yellen about the possibility of rate hikes to light the fuse on this selloff.
The market reacted instantaneously and has been selling somewhat indiscriminately ever since, as increased interest rates negatively affect the profit margins of companies and, therefore, of traders.
But with a ripping U.S. economy and a 6.4 percent GDP print, rates staying near zero makes little sense. Moreover, the fast rise of inflation has turned the screws on the Federal Reserve, forcing its hand to make a move sooner rather than later.
These converging realities have led swiftly into the market selloff we’re experiencing the past two weeks.
Even some historic perma-bulls have begun to reconsider the environment surrounding this correction.
Perma-Bulls Comment on Correction
Last week we highlighted recent comments from Fundstrat’s Tom Lee, a perma-bull who continued to echo his previous sentiments by suggesting that the market was in for another rally into the summer.
Today, however, the perma-bull changed his tone slightly, predicting a near-term 7 percent decline in the Nasdaq. A pullback of this magnitude would bring the Nasdaq Composite index to a level at or around $12,400.
Meanwhile, another incredibly bullish trader, ARK Invest’s Cathie Wood, doubled down on her positive market outlook. “I love this setup,” Wood gushed on CNBC last Friday, adding that she predicts her funds will compound annual returns of 25 to 30 percent moving forward.
And though her point of view remains rosy as ever, her flagship ARK Innovation ETF is down a whopping 35 percent from recent highs.
What Should Traders Do?
The hardest question to answer from a trading perspective is how to manage a portfolio during a major market selloff.
If you’re looking to hedge your bets, it’s important to consider how you want to insure your portfolio.
Common strategies include selecting a basket of companies whose common shares you want to sell short or buying bearish put options on the index that’s most closely aligned with your portfolio holdings.
It can also be enormously beneficial to back-test trades and project different possible outcomes. There are an endless amount of different possible hedging strategies, but the key to success lies in determining which course of action is most appropriate for your holdings — and your trading style.
Once you’ve chosen a strategy, consider picking a price target on the low end to cover your positions, just as you’d set a price target on the high end in a long trade.
Market corrections are usually short-lived, rapid, and reverse before traders know what hit them. Although it’s important in times like this to have more insurance than normal, it’s just as important to cut those positions when you feel the time is right.
And always remember the age-old market saying: Stocks take the stairs up, and they take the elevator down.
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