Equity Markets are the Master Manipulator
Why do most active investors lose money over time? The answer is recency bias. Recency bias is the tendency for investors to emphasize recent events and price action when sizing up the market and making trading decisions. Nowhere else is the psychological phenomena of recency bias more on display than on Wall Street. When stocks pull back after an extended bullish move, investors flip on a dime, thinking the worst is ahead and a major bearish market correction loom.
While managing risk and knowing your time frame always make sense, investors should look for signs that a correction will end rather than look to predict the next major bear market boldly. Why? Trends tend to persist, corrections in bull markets resolve to the upside more often than not, and extended bear markets only come around once every four years on average.
2024 Has Spoiled Investors
The 50-day moving average is the most popular metric investors use to analyze the intermediate trend in equities quickly. Yesterday, the Nasdaq 100 ETF (QQQ) and the S&P 500 Index ETF (SPY) sliced below the moving average for the first time in 2024. Though the action was undoubtedly bearish, context is paramount on Wall Street. The S&P 500 Index just registered its longest streak above the 50-day moving average since 2011 and the tenth longest streak since 1950!
Image Source: Charlie Bilello, Creative Planning
Meanwhile, the S&P 500 Index has not suffered a 2% down day for all of 2024 and is putting together a historically formidable streak together in that department. In other words, the historical data tells us that 2024 has been abnormally tranquil, and a pullback was due.
Pullbacks Within Bull Markets are Normal
“23 of the past 44 years saw the S&P 500 correct 10% or more at some point during the year. 13 of those years finished higher, up 17.5% on average,” says Ryan Detrick of Carson Research.
Image Source: Ryan Detrick, Carson Research
Though the market is likely to continue its uptrend into year-end, investors can be chopped up during short-term pullbacks. How should investors handle choppy markets/pullbacks, and how will they know the worst is over? Below are 3 things to consider:
Handling a Pullback
The ProShares Ultra VIX ETF (UVXY) and other volatility products are back above their 50-day moving averages, signaling an expanded volatility environment. When price ranges widen, investors should button up risk, trade lighter, and/or hedge long exposure until the dust settles.
Image Source: TradingView
Change of Character
The major U.S. indices have been falling on negative news. If stocks begin to rally on poor news, it would indicate a subtle change of character in the market and would be the first step in cementing a tradable low.
Follow the Leaders
Several leading stocks, such as Nvidia (NVDA), Super Micro Computer (SMCI), MicroStrategy (MSTR), and Coinbase (COIN), are testing their rising 10-week moving averages. If these stocks can find buyers at this critical level, it would be a tell that the market may be ready to turn.
Image Source: TradingView
Bottom Line
Investors need to be aware of human tendencies and “recency bias.” Corrections during bull markets are ordinary and necessary. Nonetheless, how investors handle them is everything.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
