Why the 206 Point Drop in the Dow on Monday is Instructive

Dow

How can we explain the news looking so good and the market performing so poorly? The momentum of price movements themselves can and do move markets a lot as well.

Monday started out so promising. The Dow was up 175 points at the open, basking in the further promise of a successful trade deal between the U.S. and China which has been driving a lot of the recent market gains over the last few weeks. The sun was shining and there was hardly a cloud in the sky. We looked like we were about to overcome the recent sluggishness since the high of Feb 25, which we were quickly approaching and about to overtake.

Then, seemingly out of nowhere, the selling frenzy hit. Since we gapped up, it isn’t that unusual for the gap to be filled or at least partially filled. When it’s a gap up, this means traders on the NYSE may be looking to take profits or just following the old saw that gaps often move towards getting filled in early trading when they start out that way, and then seeing this particular phenomenon emerge and jump on.

Depending on how much selling momentum is out there, we might see this stop, retaining some of the gap up and then moving back in the positive direction, and sometimes there might be enough of this out there that it can go on for quite a while, as we saw Monday.

We might think that only intraday traders, and particularly the type we can scalpers, would care about these sorts of trends, those looking to make a quick buck by holding stocks for brief periods of time. The longer-term view is supposed to be guided by what we may consider real data, how companies are doing or how the economy is doing or some other hard facts independent of market behavior.

If you look at the market from this longer-term perspective, you will see these trends as well, like for instance the drop we saw late last year and the recovery that we’ve seen since. We’ve flattened out on the daily chart for instance but the trend is still up, for now at least, but when we look at intraday charts, they move up and down in ways that we really can’t explain with fundamentals or news, what some people consider to be the noise in the market.

This might seem like noise to investors, but one man’s noise can be another man’s signal, and when we look at intraday trends and vacillations, people are indeed trading on this apparent noise, and it does manifest in discernible trends on all time levels. It all depends on your perspective.

People Jumping on Trends Sustains Them

Price action itself creates signals, a lot of them, and no matter what perspective we look at, there are always signals. This is far from random, and looking at very short bars such as 1 minute or even 1 second can be illuminating for those not accustomed to this, where there are distinct trends that emerge that people actually trade and may trade quite successfully if they are good enough.

The key here is to understand that price itself does move markets along with everything else that weighs in, and there are good reasons for this. When price is moving in a certain direction, it carries with it a life of its own, which we call price momentum.

No matter what time frame you are looking at on a chart, you will see this, bursts of activity in one direction or another for far longer periods than could be described as random, as the price itself attracts more buying or selling in the direction of the trade, until the current momentum becomes exhausted and the other side takes over for a while.

These movements are of various magnitudes and durations, and sometimes they can be sustained for quite a while in a measurable way, whether that be on long or short timeframes. The selling pressure for instance on Monday just went on and on, until we dropped the amount the market gapped up and a whole lot more.

It wasn’t until 4 hours later that this move exhausted itself, where those eager to sell right now had finally all had their say and the order flow changed from more buying pressure than selling, and we ended up gaining over 200 points back on the Dow by the time the closing bell rang.

This is not all that unusual for a down day but we usually see something that we can say is driving this, some sort of what we could call bad news for the market, but as we can see, it’s not just about this. On any given day, you have events creating and contributing to market momentum, alongside what we could call pure price momentum, and both influence things.

Price momentum does not just doesn’t appear on intraday charts, but on any time frame. If we look back on the two major trends we have seen in the market of late, the drop in the final months of 2018 and the resurgence since, price movement has influenced both, by way of reasons that make perfect sense.

People Are More Disposed to Go with Rather Than Against Trends

If we are looking to buy stocks, it is only natural that we will be more disposed to do so when the price is rising than falling, and vice versa if we are looking to sell. A reversal happens, for whatever reason, and as it moves in the new direction, more people get in on it.

There are plenty of investors that just buy without any thought, their monthly investment allotment we’ll say, and this does serve to keep the overall trend upward as long as this continues, but even this is affected by trends, as more people invest more when markets are rising and less when they are falling.

While the phrase “monkey see monkey do” may seem a little crude to use with financial markets, markets are filled with monkeys who watch one another and look to imitate the crowd. Perhaps if we were monkeys, we might even coin the phrase “human see human do,” because humans do a lot more of this than monkeys, and this might be an even more appropriate way to describe imitative behavior.

Perhaps unlike this behavior in monkeys, and a lot of human imitative behavior as well, the sort we see in markets actually often does make a lot of sense, and many people make fantastic livings being an imitator, as long as they nimble enough to not overstay their welcome when these fads change, like those who got off the slide after riding it for 4 hours and jumped on the opposite train.

Intraday market monkeys are a different breed though, whether human or machine, but the real lesson here is that this does indeed apply to all timeframes, and you can look at monthly charts over a period of years and see a lot of distinct trends, like the uptrend we’ve been in during the last 10 years.

Whatever game you play, whether this be with microsecond trades that computer trading often uses, to plans on holding positions for years, there is a show that goes on, and this show involves more than just company fundamentals, macroeconomic indicators, or any other exogenous factor that shapes the sentiment that price measures, but certainly not anywhere near totally.

When we look at a chart, we are seeing the sum of all of the forces that act upon stocks at any given time, and this certainly does include the force of price momentum. Momentum itself does drive stock prices, for example our 10-year bull market has been influenced by a lot of other things, but the move itself is also responsible for a lot of it, because rising markets attract more money which further drives prices up.

If we believe that this is all about exogenous influencers, days like Monday don’t make sense, but markets are entirely about supply and demand at any given point in time, the core of the matter, forces that are influenced by a great number of things including the flow of the supply and demand itself.

Days like Monday, where the market loses quite a bit through no apparent reason, can serve to show us just how influential price momentum can be, when we isolate it like this. It is there on other days as well, it just isn’t quite so easy to see, especially if we try to pass off everything as the result of news.

The real answer to why a market has moved so much in one direction or another can simply be explained by more buying then selling pressure or vice versa. Monday, we had more selling pressure, it’s as simple as that. The why of it matters less than we may think.

This is why it does pay to pay attention to trends no matter what approach you like to use. The market speaks, it tells a story, a valuable one, but only if we are listening properly.