Is This Market Decline Challenging ‘Buy on the Dip’ Thinking?

10/02/2014 5:15 pm EST


Jim Jubak

Founder and Editor,

Given the market's recent retreat, we may be seeing a shift in investor psychology, and MoneyShow's Jim Jubak thinks we'll be able to tell even more by looking at how the market reacts on Friday and Monday in tandem.

What we're seeing in the US stock market over the last couple of weeks is a test of "Buy on the Dip."

With a 10% correction a distant memory for the Standard & Poor's 500 stock index (SPX) and even a decline that lasts for more than three straight days so rare that it's hardly worth worrying about, the profitable reaction has been to buy on any dip.

The recent retreat that today took the S& P down to 1926.03 intraday before a reversal led stocks back up to close at 1946 (flat for the day) poses a serious challenge to that thinking.

The index fell through its then-50-day moving average at 1975 without buyers emerging in force and today it moved down through the November 2012-to-February 2014 trend line around 1946 without much difficulty. The subsequent move back up stalled near resistance at 1950.

These technical levels are a good measure of investor psychology. And what they're saying to me right now is the drop from the September 18 all time closing high of 2011 on the S&P 500 to 1945 isn't enough to bring out the buyers. The dip is just 3.3%-nothing in the scheme of things-but that kind of retreat has, in 2014, been enough to trigger buying on the dip. The fact that this drop hasn't produced that reaction-so far-is important. It's a signal that investors and traders are thinking that maybe they want to hold onto their cash for a little longer because the trend is still downward.

In other words, we may be seeing a shift from a "Buy on the Dip" psychology to a "Don't Fight the Trend" view of the market.

"May be" is a crucial phase here. Tomorrow is a Friday and the end of the week can bring a recovery in a down market as anyone shorting a stock, or stocks, decides to close out short positions ahead of the weekend. Friday also brings what is expected to be a positive September jobs report, with economists surveyed by looking for the economy to have created 210,000 jobs after adding just 142,000 (before revision) in August.

I don't know whether tomorrow will be a good test of market sentiment, in other words. I do think we'll be able to tell something about the thoughts of the crowd by looking at Friday and Monday in tandem. If an up move on Friday is followed by weakness on Monday that would point to further questioning of "Buy on the Dip" psychology.

The current 1946-1950 level is an important indicator to watch to see if the market has enough upside conviction to move above resistance at 1950 or to see if downside pessimism has enough weight to sink the S&P below support at 1946 on a closing basis.

The next big downside marker is 1900.

If we go through 1946, I'd expect to see the forces of buy on the dip rally for a battle at that 1900 level. If we were to go through 1900 without the emergence of buy on the dip, then I think it's time to think about the potential of the current weakness to lead to something like a real correction. A drop from the September 18 high to 1900 would be 5.5% or about halfway to the correction that we haven't had for so long.

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