What Happens As Markets Reverse Towards "Missed" Selling Opportunities?

by: Barry Ritholtz

I was out of the office all day yesterday, so I missed all of the fireworks. This is the 40,000 foot view, once removed, from someone not staring at the screen all day.

Following Tuesday's 250 point swoon, by mid-day Wednesday, markets had tagged on another 1% drop. That 2-day 3% or so fall set up conditions of a counter-move (Click to enlarge Marcello's charts at right).

Indeed, yesterday morning, the oft bearish Doug Kass was a buyer of money center banks (JPM, BAC, C), Brokers (MER) and Google (NASDAQ:GOOG) - so much for his perma-bear label.

With the markets ripe for an oversold bounce, there were several likely sources of the synchronized move up:

• Whatever selling pressure from overseas abated when European markets closed;

• The round number 12,000 (psychologically important to some) was briefly penetrated, bringing out buyers;

• CME sources had Morgan (NYSE:MS) as a huge buyer of SPMs on the rally;

• Stocks rallied sharply in what eerily resembled the action of a currency intervention (via Bill King);

• Anticipation of a pre-option expiration rally on Thursday had some people jumping the gun a day early; King describes this as "competition for trading profits forces traders to front-run other traders’ proclivities. Ergo, traders tend to jump the gun once a pattern becomes evident."

Why jumping the gun? Consider the corrections over the past few years (closing basis peak to trough):

2004 - 9.2%
2005 - 8.5%
2006 – 8.0%
2007 at 12:55pm 3/14, about 7%.

Traders keep doing what has been working until it stops. That pattern of anticipating what the rest of the trading community is about to do and then jumping in front appears to be alive and well. The key question facing investors (as opposed to traders) is what happens as markets head back towards prior "missed" selling opportunities - will resistance bring out the sellers, or will momentum propel us to new highs?

Think about it this way: If you missed the opportunity to sell, to hedge or to get short prior to the initial 2/27 plunge, what will you be doing as we approach those levels this time?