Stock Market Bounce Could Cause Drop and Retesting of Low

Some Wall Street analysts caution that a bounce in the stock market will cause a drop and a retesting of the low. Prominent analysts observe that there was a similar pattern noticed in February 2018 and August 2015. This is particularly relevant for investors who want to get back to the market after the rush to sell subsides. But they shouldn’t go after the initial bounce.

Dow Jones’ Feb 26 Slip-up 

On Wednesday, Feb 26, the Dow Jones Industrial Average (DJIA) slipped lower after having soared by over 460 points during early trade. The S&P 500 (SPX) dropped too. On Monday and Tuesday, both Dow Jones and the S&P 500 suffered drops of more than 6%. That accounted for the S&P 500’s greatest loss in 2 days since 2015. The gloomy situation was accentuated by fears regarding coronavirus spreading beyond the borders of China.

Some analysts believe that even if the market reclaims ground and stocks start rising again, investors should not get overly excited. Siting examples from the 6.1% drop of the S&P 500 witnessed in February 2018 and its 7% pullback way back in August 2015. In each of those instances, the market experienced a strong rebound lasting for days or weeks before retesting those initial lows. The selloff in August 2015 was sparked by issues in the equity markets in China and the resultant worries regarding the economic outlook of the country.

Possibility of Oversold Reflex Rally 

Concerning Tuesday’s close, analysts believe that there are clear indications of a washout in the near-term with the possibility of “oversold reflex rally”. They point out the key factors below that appear to prove his point.

Among the S&P 500 stocks, only 2% traded higher than their respective 10-day moving averages. The Cboe Volatility Index (VIX) soared higher than 20 a second day as its 10-day rate-of-change soared the highest since October 2018 and February of 2015 and 2018. Negative volume hit 97% on Monday and 98% on Tuesday as a percentage of the total volume of the S&P 500. While the widespread coronavirus epidemic hasn’t occurred before during any of the above instances, there were factors that put hopes of a global growth in doubt and brought about an extreme selloff.

Similarity between Present and Earlier Situations 

Considering the similarities between the two situations, analysts believe there is a likelihood of a strong oversold rally which, though significant, could end up being temporary.

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