The Aftermath of Tuesday's Sell-off: What Next?

Delray Beach, FL (PRWEB) March 3, 2007

The major market indices suffered a severe blow on Tuesday, February 27, with the Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Composite dropping between 3.3 and 3.9 percent. Over the past month, there has been inherent risk priced into the market, as signs of relentless optimism remained evident.

According to Chris Johnson of Investor's Daily Edge, "We often compare the effect of too much optimism in the market to someone yelling "Fire!" in a crowded theater, as investors tend to rush to the exits when the market finally stumbles. Well, the Shanghai market yelled "fire" on Tuesday, dropping almost nine percent."

The international selling quickly made its way around the globe. It then combined with Tuesday morning's depressing Durable Goods order data (which came in far worse than analysts' expectations) and ex-FOMC Chairman Alan Greenspan's recent comments concerning a potential recession looming for the U.S. economy. This triad of negative news sent sellers rushing in at a pace not seen since the market re-opened following the attacks of September 11, 2001.

What should investors do now … run into the proverbial fire and buy stocks, since the major indices have experienced the much-needed and much-discussed correction? Chris advises investors of some factors to consider before reacting to Tuesday's market meltdown:

--First, look at the implications of the sell-off and the magnitude of the drop. Consider a benchmark that provides good tech and non-tech exposure, such as the S&P 100 Index. The S&P 100 dropped 3.6 percent. This was the indexes largest drop since the long-term bottom in March 2003, in what would later be seen as the end of a multi-year bear market. Since 1990, the S&P 100 has experienced 29 single-day drops of more than three percent (30 including Tuesday).

--Second, look at the frequency and timeframe the drops occur. The average time that passes between significant moves such as the one experienced Tuesday is 165 trading days. When multiple drops of three percent or more occur within a short period, the odds of a short-term tradable bottom increase. The S&P 100 Index has had two drops of at least three percent within a week just four times over the past 17 years. All four of these occurrences were followed by strong bounces in the market over the following month. In fact, the index's average gain over that month is 10.3 percent.

--Third, consider the fear factor involved. Looking at the CBOE Volatility Index as a benchmark, this typically pops when the market plunges due to increased put buying. The media buzz was on high during the Tuesday decline, as the Volatility Index finally budged from its multi-month trolling expedition around the 10 level to leap to a close of 18.31. The 64-percent one-day spike in the "fear index" is the largest on record.

--Finally, consider the CBOE equity put/call ratio. This time-tested gauge of investor sentiment often holds valuable clues as to whether a sharp decline has been met with enough fear from investors. The more the fear, the more likely that the sellers have been purged from the market … and that paves the way for market advances.

"Why does this matter?" Chris adds. "We've heard many analysts tell us that we should expect more of the same selling within the next few days. If that happens, the odds of a buying opportunity (at least for the short term) increase dramatically."

He continues, "Bottom line, the opportunity selling that hit the Street on Tuesday may not be over as quickly as investors might wish. Most international markets remained under pressure after Tuesday's sell-off. This selling should make its way around the globe a second time, though my guess is that some buyers will begin to test the waters after being crowded out by the sellers on Tuesday. From the quantified measures discussed here and others I'm monitoring closely, the odds of a short-term buying opportunity cannot be ignored."

For more information and to read the full article, visit Investor's Daily Edge at http://www.investorsdailyedge.com/archive/index.php

About Chris Johnson

Before starting Johnson Research Group LLC, Chris worked in the financial services industry as a broker for 11 years and eight years as Director of Quantitative Analysis and Market Strategist with Schaeffer's Investment Research. Through this work, Chris became an expert at quantifying and studying the behavior of investors and financial markets, market sectors, and indices. Along the way, Chris has developed numerous market analysis tools that harness the powerful combination of behavioral and technical analysis.

Chris is a contributor to Investor's Daily Edge and frequent commentator on financial markets and is regularly seen in national print media, such as Barron's, Wall Street Journal, Financial Times, Bloomberg, USA Today, and the AP Newswire. In addition to being a guest on several radio shows, Chris appears regularly on CNBC, Bloomberg TV, and the Fox News Channel as an expert in the field of sentiment and investor behavior as well as technical analysis.

Investor's Daily Edge (http://www.investorsdailyedge.com) is a free investment newsletter that's delivered by email before the market opens. In each weekday issue you'll receive clear recommendations and practical strategies for protecting your portfolio and multiplying your money - whether the market is rising or falling.

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