It was a pretty nasty day yesterday on the Aussie Markets…
The All Ordinaries lost more than 2%.
And it’s set to continue today, with the futures market pointing to another 65-point loss.
Is this anything to worry about?
Should you get out of the stock market and wait for things to die down?
In today’s essay, I’m going to give you some tips for dealing with a scary market. Because it’s not easy, especially if you’re new to this stock market game.
The first thing to remember is that you’re dealing with the unknown. You don’t know what tomorrow, next month, or next year will bring.
Investors don’t worry about this essential truth so much when the market rises everyday. But it tends to dawn on them when a few bad days smash their portfolio by 5%.
That’s why you need a process. If you don’t have a process, or an investment framework of some kind, you’re flying blind. When that happens you tend to make bad decisions.
Which brings me to another important point.
We are governed by our brain. Kind of an obvious point, I know. What I mean is that our brain didn’t evolve to help us out in scary financial markets. Its evolutionary impulse is to run from dangerous situations.
So when the Aussie stock market drops sharply, like it did yesterday, the fear receptor in your brain (the amygdala) fires up. Your evolutionary impulse is to put the fire out. You want to rid yourself of fear.
That’s why the natural impulse is to want to sell. Selling douses the fire and the fear recedes. But then, the market turns around, and the greed impulse hits!
How to deal with a falling Aussie Market:
How do we avoid this emotional yo-yo?
As I said, have a process.
My process is part technical, part philosophical.
The technical part is that I only buy/recommend stocks that are of reasonable value and have good charting set ups. This combination usually keeps me out of major trouble.
The philosophical part is that I know I really don’t know much. I’m happily ignorant about what the market will do. I’d prefer to let the market tell me what’s going on rather than impose my (probably wrong) beliefs and biases on it.
That’s why I analyse charts a lot. The charts are just a record of the buying and selling decisions of ‘the market’. Given that translates into millions of individual decisions made with real money on the line, I’m happy to wager that the market knows a lot more than me.
With this in mind, let’s have a look at the All Ordinaries index. Let’s see what the market is saying. Here’s how I interpret it, anyway…
As you can see, the market recently popped up and made a new all-time high. But like what happened in July, investors quickly sold the high and sharp falls resulted.
When price breakouts aren’t convincing, it’s usually a bearish sign. Not bearish as in OMG the market is going to crash 50%. I mean bearish in that the market is likely to fall a bit and/or do nothing for a while. That’s what looks like is happening here.
But I wouldn’t get too bearish until I start to see new lows form. The first area of support is around 6,770 points. That’s the lows from November. But it wouldn’t be a big deal if support here gave way. It could just mean the market is in a sideways trading pattern.
It would be more worrying if support at 6,600 broke…and then 6,500. That would point to a change in trend and potentially the start of a longer and deeper bear market.
Until that happens, I’d say this is just a standard bull market correction.
The other point to note about yesterday was the fact that the Small Ordinaries index outperformed the broader index. Usually, smaller stocks underperform. That’s because they are more sensitive to changes in the economy.
The fact that they outperformed yesterday suggests the driver of the sell-off wasn’t a reflection of a fundamental change in the economic outlook. That’s a good thing.
But longer term, the Small Ordinaries have actually underperformed. As you can see below, smaller stocks didn’t break out to new highs last week like the All Ords did.
What does that tell you?
It suggests the recent rally has a lot to do with the RBA cutting rates to the bone and threatening QE. Investors are rushing into large-cap stable dividend payers to find some income. They’re also punting on consumer stocks on the back of the east coast house price resurgence.
Both the consumer staples index and the consumer discretionary index fell sharply yesterday. So it looks like yesterday and today is a partial unwinding of this popular trade.
For me, the key level to watch for is the August lows. If stocks break below there, it will increase the odds that we’re entering a bear phase. At that point, you’d be right to panic…
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