What Does Thursday’s Mystery Downdraft Mean?

“There are known knowns. These are things we know that we know.

There are known unknowns. That is to say, there are things that we know we don’t know.

But there are also unknown unknowns. There are things we don’t know we don’t know.” – Donald Rumsfeld

One of the most bearish things about yesterday’s downdraft is that there seemed to be no ostensible catalyst for the selloff.

Some say it was a headline out of China that the numbers of the outbreak were getting worse, but on Wednesday, reports out of China said the rate of new cases was slowing.

Does this remind anyone of “we have a trade deal, we don’t have a trade deal” of last year?

The Algomatics ‘hear’ the word ‘China’ and go haywire.

I can’t help but wonder if there isn’t a group trying to manipulate the market.

That doesn’t really happen, right?

Long time readers are familiar with my dad’s saying: “Stocks don’t move, they are moved.”

Many believe the market’s role as a fundamental discounting mechanism has become more warped in the last decade due to Fed intervention, which has injected artificiality into genuine price discovery.

Known knowns became dominated by unknown knowns.

With the outbreak of the coronavirus, the market has had to confront an unknown known.

After the initial panicky swoon in late January, the market rebounded to new all-time highs, tainting the tape with the idea that the market was doing a good job of discounting the unknown.

However, the more time goes by without answers, the more the market is vulnerable to having to deal with unknown unknowns.

This creates more emotionalism than in the markets, which is the kind of volatility we saw yesterday.

It wasn’t just the expansion of volatility witnessed on Thursday, it was the sheer velocity of the drop that was stunning.

As traders, what can we do to be disciplined when emotion dominates the tape?

Price.

Price is the final arbiter — whatever time frame you’re trading on.

Jesse Livermore said, “All through time, people have basically acted and reacted the same way in the market as a result of greed, fear, ignorance, and hope. That is why numerical formations and patterns recur on a constant basis. Over and over, with slight variations. Because markets are driven by humans and human nature never changes.”

Price patterns are simple to understand and learn.

However, the hard part is sticking to your plan — following your process — pulling the trigger and adhering to your plan when things get tough.

But, those are exactly the times that your trading plan and trading rules are the most important… and the hardest time to stick to them.

Below is a post-it I have on my computer:

Discipline leads to process

Process leads to conviction

Conviction leads to patience

Patience leads to success (courtesy Mark Yusko)

Why is patience so important?

Because patience represents a belief in your process and your plan.

It means the patience to wait for the best setups and the whites of market’s eyes.

There’s an expression that my mentor at the famous Drexel Burnham office in Beverly Hills gave me when I started there in 1982:

“Good price comes to patience.”

That can mean several things to different people.

It can mean being a trend-follower and letting a trend play out.

It can also mean the patience to wait for a stock to setup.

If you are a short term or swing trader it can mean exercising the patience to stick with your trading plan:

In other words, if you entered a short term trade and it isn’t moving, get out.

You entered the trade because the stock looked poised to move.

Using a time stop in addition to a price stop requires patience — the patience to believe another setup will come along where your money can better be deployed.

Patience means not letting a day trade turn into a swing trade because the stock went against you.

It means not letting a swing trade turn into a long term position trade when the stock goes against you.

For example, COUP was a long swing setup for Wednesday from a Rule of 4 Breakout — a breakout over a 3 point trendline.

Our trigger was an Opening Range Breakout on Wednesday at 167.99.

We sold half on Wednesday, locking in a 3 point gain, trailing a protective stop at 174.90, which was hit on Thursday, and locking in a gain on the 2nd piece of 6.90.

COUP slid all the way back to 166.18 during Thursday’s air pocket. It’s revisiting that region this morning.

This is our swing method: regardless of how high (or low) it looks like a stock may project, we trim half depending on the price action and trail a protective stop on the balance. Trim & Trail.

There are two ways I gauge the line of least resistance in the market:

1) The action of the averages

2) The behavior of the leading stocks

When a leading stock like COUP breaks out and reverses with authority below the Breakout Pivot, it puts defense on the field.

Bill O’Neil says that breakouts backtest their breakout point about 50% of the time.

Not all breakouts are created equal. When an institution wants to trim, they will often use a breakout to sell into strength.

COUP retrenched below the breakout point in yesterday’s reversal.

It may be just a probe of the Breakout Pivot, but downside follow through over coming days/weeks points the way lower.

Follow through is key. One reversal day, one large distribution day does not a trend change make.

Be that as it may, COUP wasn’t the only growth glamour mugged on Thursday.

OKTA and APPF, to mention a few, also saw large range reversals on Thursday.

The averages.

An hourly SPX shows breakage below a trendline defining support for February.

Additionally, the SPX snapped its 50 hour moving average for the first time since reclaiming it earlier this month.

The SPX spent the balance of the afternoon clawing its way back to the breakpoint closing with a potential bearish backtest of its 50 hour.

The short term bearish picture is that yesterday’s close carved out the right shoulder of an HOURLY Head & Shoulders topping pattern.

Downside follow through projects to two regions:

1) The prior swing highs from January around 3333-3336. This ties to the rising 20 day moving average and an open gap from February 5.

2) 3280, which represents where the SPX gapped up to reclaim its 50 hour m.a. on February 4.

Trade below these two momentum gaps from early February would point the way lower.

As long as the 3280 region holds, the interim uptrend remains intact.

That said, the fact that yesterday’s reversal correlates to a breakout in the precious metals this week warrants caution.

WPM came out of a Cup & Handle.

Ditto GOLD.

PAAS and SSRM are on fire.

It’s not all about TSLA and the space TSLA, SPCE.

Earlier this week, we noted on our Hit & Run private Twitter feed that GDXJ looked set to tag the 45 strike going into the weekend. We positioned for the move last week with GDXJ calls.

It looks like it’s on its way this morning.

Our near term projection on GDXJ is 48.

Pos GDXJ calls, PAAS, SSRM, WPM