I mentioned in “Fear is Driving Stocks Down, or is Declining Stocks Driving Fear?” that falling prices could lead to panic selling and it may require some panic selling to push prices low enough to bring in new buying demand. Of course, to have cash to buy you had to have previously sold before the decline.

Today we’ve observed just that. The headlines today “Dow Plunging 460 points” is what I was talking about. Big down days rid weak holders of their positions they held too long, so they fear losing more money. Those of us who already sold early enough to have cash for new entries can wait for prices to get to a low enough point to make the risk/reward attractive enough to take a chance.

Although we could be observing the early stages of a much larger downside bear market that unfolds in the months ahead, they don’t drift straight down. Instead, they cycle down 10%, up 7%, down 10%, etc. When they’ve moved down, one potential sign of a reversal back up is when the worst performing areas of the markets reverse back up. I usually observe the things that were trending down the most get oversold and are the first to shift back up, at least temporarily.

The chart below is the past 2 days of the S&P 500 (SPY), Russell 2000 Small Company stocks (IWM), the Energy Sector (IYE), and Energy MLPs (AMJ). As I’ve pointed out lately, smaller companies and energy have declined the most and on today’s big down day for stocks, you can see below those weakest areas are drifting up. It’s a positive sign in the days ahead IF that continues…

Chart courtesy of http://www.stockcharts.com

The way directional trends unfold is they sometimes get to a point like they are now and reverse back up, if prices have gotten low enough to attract enough new buying, that buying ends to fall. But if that doesn’t happen, this is what the early stage of how even more panic selling begins. I believe everyone has an exit point. Even those who say they are passive and “buy and hold” eventually panic when their losses get too large. Stock indexes have only fallen about -9% from their peak a few weeks ago, so that probably isn’t yet enough to drive too many out  who are 100% invested, but you can probably see how as their losses get larger and larger many of them do eventually exit.

I think everyone has an exit, an “uncle point”, it can either be an earlier predefined exit like mine are, or after their losses get so large they can’t take it anymore (-20% or 30%) or to the point it begins to change their life plans (like -40% or 50%).

Let’s see how it all unfolds…

If you are an investment adviser or individual investor and don’t have a strong track record of active risk management, now is a good time to get in touch.