Takeaways From Tuesday’s Violent Drop

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Just when you thought the volatility was fading, sessions like yesterday’s happen.

The S&P 500 and Dow Jones Industrial Average both had their biggest drops since October 10’s epic bloodletting. For the Nasdaq-100, it was the worst since October 24.

Most press reports focused on uncertainty about China and the inverted yield curve, but plenty of other things were going on.

First, we entered the session massively overbought. The S&P 500 was near the top of its range following its biggest weekly gain in seven years. It was also above its 50-day moving average for the first time in two months.

Viewers of our Monday afternoon Market Action power-hour also had access to a special custom indicator comparing the index to its 10-day moving average. Do you know it was more than 3 percent above that line, indicating an extreme overbought condition?

Want access to ideas and up-to-date platform tips? Watch Market Action every Monday at 4:30 p.m. ET.

Next, the S&P 500 seems to be consolidating in some kind of range. It could be either a channel or a sideways triangle. Monday’s high was slightly low than the November 7 peak, while the Thanksgiving-week low was slightly higher than October 29.

S&P 500 with moving averages, narrowing range and custom indicator.

Traders should be aware of this pattern because it could get narrower. Triangles can be frustrating and painful, but at least now you might see it coming.

Some levels also seem to be in play. The Nasdaq-100, for instance, seems to have slammed into resistance again at the 7000 area. Ditto for the Philadelphia Semiconductor Index around 1240. However the S&P 500 did hold 2700.

As reported on Market Insights yesterday, safe-haven sectors continue to outperform versus “risk on” cyclical areas. (Click here for more on the slowdown in chips.) Speaking of safe havens, Treasury Bond futures (@US) rallied above their 200-day moving average for the first time since the start of the year.

Finally, our Master Classes teach how to identify when good news is “priced in.” (That’s potentially bearish.) Yesterday’s drop seems to have been a classic example of that phenomenon after the Federal Reserve turned dovish and President Trump spoke of a trade deal with China.

The resulting optimism was good enough to get the S&P 500 back to the top of its range, but insufficient for a breakout.

In conclusion, a lot of forces were pushing and pulling on the market yesterday. Hopefully this post helps you to make sense of the volatility tomorrow.

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David Russell is VP of Content Strategy at TradeStation. Drawing on nearly two decades of experience as a financial journalist and analyst, his background includes equities, emerging markets, fixed-income and derivatives. He previously worked at Bloomberg News, CNBC and E*TRADE Financial. Russell systematically reviews countless global financial headlines and indicators in search of broad tradable trends that present opportunities repeatedly over time. Customers can expect him to keep them appraised of sector leadership, relative strength and the big stories – especially those overlooked by other commentators. He’s also a big fan of generating leverage with options to limit capital at risk.