Should You Worry About Another Market Selloff?
Stocks have been moving up since March. But as I pointed out last week, large investors like Warren Buffett are selling. Recent news indicates small investors have been buyers.
CNBC reported that “trading stocks was among the most common uses for the government stimulus checks in nearly every income bracket, according to software and data aggregation company Envestnet Yodlee.
People earning between $35,000 and $75,000 annually traded stocks about 90% more than the week prior to receiving their stimulus check.”
The Robin Hood Effect?
Zero commissions are probably one reason that so many individuals are investing. App-based brokers like Robin Hood are also a reason so many new investors are active in the market.
While Robin Hood has advantages and disadvantages, the site does offer a rich data set for analysis. For example, it’s possible to see exactly what investors are buying and selling with the app. The chart below shows the stocks with the largest changes in the past week.
For example, the top line indicates that Moderna, Inc. (NASDAQ: MRNA) was added to 58,948 accounts. It’s now owned in almost 200,000 accounts at the broker.
MRNA, and the second stock on the list Sorrento Therapeutics, Inc. (NASDAQ: SRNE), are both in the news because they are reporting progress in developing a vaccine against COVID-19.
Almost all of the stocks on the list are in the news. That indicates Robin Hood investors seem to be driven by news and rumors. This is consistent with Robin Hood management’s description of customers as new investors and younger, mostly millennials.
This has some important implications for market analysis. First of all, it offers an explanation of the market action over the past few weeks. Prices stalled after a rapid advance.
Traders like to say rallies end when the market runs out of buyers. While there are millions of investors trading their stimulus checks through Robin Hood and other brokers, they are small investors. Even collectively, they won’t necessarily have the buying power to push major indexes up by much.
Additional gains will require the participation of larger investors. And the futures market tells us that large investors aren’t as bullish as small investors.
What The Big Boys Are Doing…
There is an indicator based on reports filed by large investors in futures markets every week. The Commodity Futures Trading Commission (CFTC) issues a weekly report showing how many contracts various groups of traders own.
The CFTC assigns all positions to one of three groups – commercials, large speculators, and small speculators.
Commercials are producers and consumers of the commodity. In the oil market, commercials include oil producers and large consumers like airlines.
These are companies that know they will always need to buy or sell oil. They use the futures markets to get the best price. When commercials believe prices are going up, they take large positions ahead of the rallies.
Typically, commercials are the “smart money” in a commodities market. In the S&P 500, commercials include investment banks and market makers. Their actions are driven by the positions large traders take and they use futures to hedge their own positions.
Large speculators are hedge funds. In the S&P 500 futures markets, large speculators tend to be trend-followers. They tend to buy more as rallies unfold and take larger short positions as bear markets drag on. This means large speculators should have their largest positions when markets top or bottom.
The COT report also shows what small speculators do in the market. These are individual investors who trade futures.
The weekly report containing this data is known as the Commitment of Traders (COT) report. The raw data tells us the number of contracts each group holds and is shown in the chart below.
Small speculators have accumulated large positions. Meanwhile commercials and large speculators are short, which means they expect prices to fall.
We can see small speculators behaved in a similar manner after the initial selloff in 2000.
Small investors buy the dips while large investors tend to use the dips to reduce their exposure in the market.
Right now, we have small investors buying while large investors are selling. This indicates that we should expect a selloff in stocks, and I expect the selling to start within the next two weeks.
That doesn’t mean you should completely bail on the market, however. As I explained in this piece, I’ve been making successful trades on the same fund for weeks now. And I just entered our fifth trade.
I’m also making “bonus dividend” trades on undervalued stocks. As I explained in this piece, my readers and I can expect to make an extra 10% on a recent trade, while also practicing caution in this market.
Another strategy to consider is the one used by my colleague Jim Fink.
Jim is a seasoned pro who has developed a proprietary options trading method that consistently beats Wall Street at its own game. And that’s true in markets that are going up, down, or sideways.
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