Why Bad Things Happen Under the 200-Day Average

Bad Things Happen Under the 200-Day Average

To describe this wild week as anything but the epitome of craziness would be the height of understatement. So, I’ll dispense with a recap and just say that the nearly unprecedented volatility and market swings since Wednesday, Aug. 19, are an example of the kinds of bad things that tend to happen when stocks trade below their 200-day moving average.

When markets plunge below the 200-day average, there’s a heightened sense of fear from both traders and investors that this could be “the big one,” i.e., the start of the next big market downturn.

On Monday, the first hour of trading seemed like we were headed for just such a death spiral, as the Dow plunged 1,089 points in the first five minutes.

Perhaps more disturbing was the plunge in many exchange-traded funds (ETFs) that morning. The massive mispricing of many of the market’s biggest ETFs is being called a “mini flash crash.”

The reason why is because some ETFs were down 30%, 40% and even 50% in early Monday trade.

One main reason for this was the influx of sell orders that flooded the market after so many individual investors went to their online brokerage accounts to put in sell orders “at the market.”

Another key reason that caused these massive price discrepancies was a little-known, and rarely used, Securities and Exchange Commission (SEC) regulation called “Rule 48.”

Rule 48 permits designated market makers to not tell anyone where things are going to open until they start trading. This lack of transparency takes critical information away from markets, and the “blindness” that ensued allowed so many to sell into the landslide.

While Monday’s extreme volatility hit ETFs very hard, it was far less a case of a flaw in the ETFs themselves that was responsible for the mispricing and much more a case of poor management, bad rules and scared investors running for the exits.

One way to remove the fear is to not be in stocks when they trade below their 200-day moving average. This critical principle is what my Successful ETF Investing newsletter service has been built on for nearly four decades.

In addition to not tempting fate and being in stocks when the fear factor is high, you also should not be trading during the first hour, especially on a Monday after sell orders have backed up during the weekend.

Moreover, you should not use “market orders” when you trade. Rather, you should use “limit orders” which will only be filled at the price floor you set.

Finally, do not trade when the markets are gyrating like crazy.

If there is one lesson to takeaway from this week, it is this: in times of turmoil, it’s best to keep your head about you, stay calm and look carefully before you leap.

If you are a serious ETF investor, now more than ever you need my Successful ETF Investing advisory service. My subscribers remained calm, and in the safety of cash, throughout the past couple of volatile weeks, and as such, our portfolios remain intact.

The Power of ‘If–’

If you can keep your head when all about you
Are losing theirs and blaming it on you…
Yours is the Earth and everything that’s in it,
And—which is more—you’ll be a Man, my son.

— Rudyard Kipling, “If–”

Weeks like these remind us that keeping our heads about us at all times is a most-important virtue. In fact, whenever things in your life get crazy, you might want to sit down and read a little Rudyard Kipling and study the life lessons in his masterwork, “If–.”

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow Weekly ETF Report readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Ask Doug.

In case you missed it, I encourage you to read my e-letter column from last week about three major market indices approaching bear market status. I also invite you to comment in the space provided below.