The Bears are Eating Your Tech Stocks

The stock market continues to drag investors into a pit of despair as the major averages post another ugly week of losses.

The Nasdaq took the brunt of the damage, tumbling more than 5% in just ten trading days as the once bulletproof mega-cap tech stocks began to unravel. The bears have now come for the biggest and best stocks on the market, with major players like Alphabet Inc. (GOOG) suffering double-digit damage.

At first, it looked as if some of the more beaten-down growth names might find some relief while the mega-caps underperformed. But many of these stocks continue to find new lows as distribution dominates the tape. Nowhere to run, nowhere to hide…

Naturally, doom and gloom predictions are flooding the airwaves as the market continues its fall slump. It’s spooky season — and slippery stocks are starting to scare the pants off investors.

The absence of new highs, poor breadth, and sluggish action is taking its toll on the bulls. It’s gotten so gloomy out there that World War 3 and Black Monday have been trending on social media. Investors are on the verge of panic every weekend, expecting cataclysmic events to rip through the markets, sparking a historic crash.

But is the situation for stocks really that grim?

Not yet…

While we’ve yet to witness a significant breakdown, the averages remain mired in a choppy, sideways trend. Last week’s action was especially difficult. The S&P lost 2.5% to close at its lows on Friday, hitting levels we haven’t seen since late May. The summer melt up has melted down as the large-cap index has dropped more than 10% from its highs.

But if you have even a drop of contrarian blood coursing through your veins, you’re probably on the lookout for a bounce this week. We’re entering a seasonally strong period for stocks, sentiment is in the gutter, and the averages are near obvious support levels.

Push the news, panic, and upcoming Fed meeting out of your head for a moment. Instead of focusing on the noise, let’s instead plot out a couple of potential scenarios for stocks as November approaches.

What Happens Next? 

First up: the unexpected rally.

We could see a quick washout below key support to set up an end-of-year rally. In this scenario, the major averages and some of the more popular stocks undercut support (their respective 200-day moving averages or other obvious, horizontal levels).

Sellers then come for the strong names and mega-caps as these are usually the last lines of defense and “safe havens” for the bulls. They successfully scare some weak hands out of their positions, yet fail to crater the market. Stocks find support, bottom out, and begin to attract these same sold-out bulls into a year-end push higher.

The next scenario is where it turns ugly.

If markets continue to suffer as yields and the dollar push higher, this drawdown could morph into the beginning of a major leg lower. That means we’ll see breakdowns expand and ripple through the market, tearing down leading stocks and everything in between. All the angst and worry built up over the past few weeks will be confirmed by poor earnings reactions – and maybe even a little panic following the Wednesday release of the latest Fed minutes.

All major moves lower begin with what appears to be a standard market pullback, so the move will likely catch the remaining bulls off guard as the averages defy seasonality and an end-of-year melt up turns into a full blown meltdown.

Don’t Jump the Gun

We’ve experienced choppy markets for several weeks. These conditions won’t last forever. With the averages at or near important inflection points, I expect stocks will break one way or the other sooner rather than later.

But there are no guarantees — and mistakes are incredibly costly in difficult trading environments.

When markets are trending, you can get it wrong and still make money. A little tailwind from the prevailing trend will help cover up poor decisions. Heck, you might even still book decent gains if you underperform during especially strong periods.

Don’t get me wrong — there are techniques and strategies you can use to make money whether the market is moving up, down, or sideways.

But trying to “get in early” on breakouts or breakdowns before the market tips its hand is a recipe for disaster.

Intraday swings and fake-outs are commonplace these days, while trending days are few and far between. Instead of follow-through, we’re stuck with big gaps higher or lower as traders try to wrap their minds around the endless list of risks attacking their favorite stocks.

I know how frustrating it is out there. It’s especially difficult to sit on your hands waiting for more confirmation before pulling the trigger on new trades.

But that’s exactly what you have to do in this environment.

When false breakouts and choppy conditions are prevalent, successful traders know to pull back. Protecting capital is the top priority!

There’s obviously a ton of noise out there right now, which means it’s more important than ever to tune it out and remain focused on your trading goals.

3 Ways to Beat the Chop 

As the market continues to lurch along, remember the rules that guide us in these conditions:

We’ll let price lead the way.

Don’t get too caught up in the scary headlines. Price will tell us how this market will behave in the weeks and months ahead — the narratives won’t!

Choppy action means fewer trades. 

Taking a step back from a choppy market will allow you to protect your capital, limit drawdowns due to failed breakouts, and allow you to jump on any new opportunities when they emerge due to your large cash position. Cash is a trade!

Breakeven is winning in this market.

Passive investors are watching their losses grow as stocks continue to retreat from their summer highs. So-called “growth investors” are down big as many of the prominent names in this group are down as much as 50% from their year-to-date highs. They have a long way to go before they will make those losses back.

By limiting your drawdowns, you’ll be miles ahead of the herd when this market finally picks a direction. If a trade’s not working, cut it loose. Small losses won’t kill you (but big ones just might!)

The Daily Reckoning