Stocks finally got hit with some selling pressure on Friday.
After rallying nearly 5% during the first three weeks of February, the S&P 500 lost 1% on Friday. And, if this pullback plays out the way January’s pullback did, then stocks have further to fall.
But the selling will end at some point. And patient investors will have a chance to put money to work at lower prices. The trick, though, is figuring out when the selling will end.
One of the characteristics of January’s decline was the rapid shift in investor sentiment from bullish to bearish. It took just a small, 3% decline in stocks over two weeks in late January to flip investor sentiment from extremely bullish to extremely bearish. That rapid shift in sentiment – a contrary indicator – was enough to prevent January’s decline from getting too deep.
Traders should be on guard for something similar this time as well.
On Friday, most of the financial television talking heads seemed comfortable with the decline. They’re okay with stocks pulling back some from here, and they expect any selloff will be rather mild. And, it didn’t seem that traders were rushing to sell out of long positions, or to add exposure to the short side.
That means the market probably has more work to do on the downside. It needs to inspire some panic.
Traders should keep an eye on the Volatility Index (VIX) this week. If it closes above its upper Bollinger Band (BB), then it will set the stage for a stock market buy signal when it closes back inside the bands. That will be the time to start buying stocks again.
Here’s an updated chart of the VIX…
The blue arrows point to all of the previous VIX buy signals over the past year. Each of them proved to be an excellent time for traders to step up and buy stocks. The next buy signal will likely prove profitable as well.
But, we’re still at least a few days away from getting that buy signal. The VIX closed inside its Bollinger Bands on Friday. It’s going to take some additional selling pressure today (and maybe tomorrow as well) to push the index to close above its upper BB. And, once that happens, it’s going to take another day or two for the VIX to close back inside the bands and generate a buy signal.
So… stay patient. We’ll likely see more selling pressure in the stock market early this week. But, keep an eye on this chart of the VIX. It will tell us when the selling has ended.
Best regards and good trading,
Jeff Clark
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