The stock market had fallen into a rare rut on Friday and Monday, with one of the narrowest non-holiday trading ranges in history on both relative and absolute measures. But the quiet was shattered on Tuesday in a roller-coaster session that featured an initial surge to new highs in the Nasdaq Composite and the S&P 500 before the sellers hit hard.
The result was the Dow Jones Industrial Average’s worst one-day loss in five weeks and the formation of a significant technical warning signal. Amid a hairy and uncertain geopolitical situation, rising inflation and an 8% wipeout in Dubai’s stock market, investors suddenly became skittish.
Will it continue?
To be sure, the result was unexpected given the strength the market has demonstrated on Tuesday’s recently. In fact, the Dow almost suffered its worst Tuesday performance in eight months. So a major pattern of strength has been broken.
Or at least threatened.
Investors were also apparently reacting to a series of negative headlines. It started with a stronger-than-expected auction for two-year Treasury bonds, a sign that the bond market is feeling nervous. And that nervousness, in turn, started to bother the stock market. There were reports of a Syrian airstrike in northern Iraq around the same time, threatening to escalate a powder keg of a situation there.
Then, the selling intensified on reports out of Ukraine that a cease-fire agreement has been broken after Ukrainian military transport helicopter was shot down. Russian media is reporting the Kiev has restarted the shelling of pro-separatist strongholds.
The ferocity of the intraday reversal has a lot to do with how high strung investors are right now. In fact, the Credit Suisse Fear Barometer, which measures the relative cost of put vs. call options, has never been higher. When there is more demand for downside protection, as there is now, the Fear Barometer rises.
Much of this buying of put options is hedging activity by institutional traders (think hedge funds) who have historically been pretty good market timers. A fresh peak in the Fear Barometer was hit as the market topped back in 2007.
And finally, the Nasdaq’s turn at resistance from its March high formed what chartists call a “hammer” pattern indicated by a big intraday rally that was more than fully reversed. That’s a sign of buyer exhaustion that normally ushers in a bout of short-term weakness.
In response, I’ve recommended my Edge Letter Pro clients look to profit from a potential downside move in tech stocks by adding a July $34 put option position against Yahoo (YHOO), which is falling through its multimonth support level.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he had recommended YHOO puts to his clients.