Veterans Warn More Pain Ahead for Stocks and Crypto

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  • Stocks reversed sharply on Monday as major indexes closed higher after opening deep in the red.
  • Some took it as a sign that a recovery was imminent; others saw more pain for risky assets ahead.
  • Three market veterans shared indicators flashing warning signs against buying the dip.

A year after the meme stock investing saga fueled by GameStop, the market is on a different kind of roller coaster.

With the


Federal Reserve

Seeking to raise interest rates and shrink its massive bond portfolio, risky assets ranging from stocks to cryptocurrencies took a hit.

As of Monday’s market close, the S&P 500’s 7.5% year-to-date decline marks its weakest start since 2008, and the tech-heavy Nasdaq’s 11.4% drop marks its weakest start since 2008. reflected in its worst start since 1972, Bank of America said in a research note Tuesday. . The widespread declines are highlighted by the fact that 61% of S&P 500 stocks are more than 10% below their 52-week highs, while half of Nasdaq stocks have fallen more than 20% from their 52-week highs.

Amid the sharp declines, stocks staged a historic bullish reversal on Monday. As noted by Bespoke Investment Group, the Dow Jones erased a decline of 1,000 points to close higher on the day for the first time ever. The company’s historical market analysis shows that Monday was also the sixth time the Nasdaq erased an intraday decline of more than 4% to close higher on the day.

The same intraday reversal happened to the crypto. After dropping below $33,000 early Monday, bitcoin bounced back above $36,000 by the end of the day. The token was changing hands at around $37,200 on Tuesday afternoon, bringing the total market value of all cryptocurrencies to $1.69 trillion from less than $1.5 trillion the previous day.

The rapid and massive reversal has some investors wondering if the end of the market chaos is near. More importantly, traders are wondering if now is the right time to buy the dip, which refers to the practice of loading downed assets in the hope that they will rebound to previous highs.

The fix is ​​far from over

For Don Kaufman, Monday’s rally seems “sketchy at best.” The veteran trader, who co-founded trading education platform TheoTrade, views SPX Weekly Options as a way to implicitly value


volatility

.

He observed that although the SPX Weekly Options for this Friday had indicated that the implied volatility was at 30 for this coming Friday, the Cboe Volatility Index or VIX had already reached an intraday high of 38.94 on Monday.

“Even after a rally, seeing volatility increase 20% to 30% doesn’t exactly leave you hot and fuzzy as a trader,” Kaufman said in an interview on Monday.

Another indicator that makes Kaufman uneasy is the inverted VIX curve, which means farther VIX futures are trading lower than closer contracts. Typically, VIX contracts are further out than closer contracts because there is more uncertainty in the future than in the near term.

“Anytime I see volatility futures reversed like this, it’s every man for himself,” he said. “The markets can then turn on you in seconds, and that’s where we get these absolutely wild rallies. I wouldn’t be surprised if the S&P moved up 100 points from here to reverse.”

Similarly, Stifel’s chief equity strategist, Barry Bannister, calls Monday’s relief rally a “head hoax.” He outlines the five factors the market will need to eliminate before finding a bottom. They include a dovish pivot from the Fed, the bottom of the US manufacturing index, the global M2 money supply and the S&P 500 EPS quarterly beat-minus-missed difference, as well as the settlement of the Russian-Ukrainian conflict.

From a technical analysis perspective, Monday’s reversal inspires optimism but also does not signal an imminent move higher, according to Mark Newton, head of technical strategy at Fundstrat Global Advisors.

Newton explained in a Monday note that “a lot of technical damage has taken place” while “the momentum is still quite negative and the extent remains poor.” Meanwhile, Elliott Wave indicators suggest markets have only formed three waves so far since January, meaning a retest and break of lows may yet occur in early February. DeMark indicators are also ahead to show exhaustion based on the TD Sequential and TD Combo indicators, he said.

“So while there is a lot to celebrate given some headline readings in many breadth and sentiment gauges are starting to come together, trying to buy dips in this dip probably won’t be as easy and should be strewn with pitfalls,” he added.

Looking for short-term bearish opportunities

As the market continues its downward trajectory, some investors are hedging, others are taking defensive positions. For skilled traders, there are still short-term downside opportunities, Kaufman noted.

Indeed, short sellers have already made $114 billion in profits in January betting against fan favorites such as Tesla (TSLA) and Netflix (NFLX), according to CNBC, citing data from S3 Partners.

Kaufman keeps his eyes on pandemic darlings, including Zoom (ZM), Platoon (PTON), Robin Hood (HOOD), and Coinbase (COIN), which could see even bigger moves outside of the broader market gyration as they head into the historically volatile earnings season.

However, he does not recommend taking a one-sided bet against these stocks given the possibility of sharp reversals. Instead, investors can use option spreads to smooth the downside.

The option spread strategy is executed when a trader simultaneously buys one option and sells another option at a higher or lower strike price using either calls or puts. The trade can be expressed in four ways via bullish call spread, bearish call spread, bullish buy spread and bearish buy spread.

With volatility remaining high, investors may also benefit from buying options a little farther into the future to manage risk.

“Volatility is so high as short-term options, their volatility is higher than options that are further back in time,” he said. “It’s a good time to buy a little further back in time.”

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