The Dow’s first stop could be 4,000 points lower....

Opinion: The Dow’s first stop could be 4,000 points lower if there’s a real selloff

Published: Sept 7, 2017 2:41 a.m. ET
So far investors have been buying the dips, but if that changes, look for a big drop to the first major support zone

By

NIGAMARORA

ANALYST

Prudent investors prepare for different scenarios. Right now, the stock market is assuming two things.

First, regarding North Korea, that people in power on all sides are rational. Second, a buy-the-dip mentality will prevail and machines that trade large volumes every day will not make mistakes. To understand that latter scenario, let us look at a very short-term chart and a longer-term chart.

Very short-term chart

Please click here for the very short-term chart of Nasdaq 100 futures NQU7, -0.11%Popular Nasdaq 100 ETF QQQ, +0.23% traced a similar chart. I picked the Nasdaq 100 because it contains popular FAANG stocks such as Facebook FB, +0.65% AppleAAPL, -0.40% Amazon AMZN, +1.21% Netflix NFLX, -0.14% and AlphabetGOOG, +0.88% GOOGL, +0.84%

The chart shows there was a dip at the open Tuesday, owing to North Korea testing a hydrogen bomb over the weekend. Prior to the open, in the Morning Capsule that is made available to the subscribers to The Arora Report, I wrote the following based on our algorithms: “The momo (momentum) crowd is aggressively buying the slight dip in the pre-market in stocks. The thinking appears to be that N. Korea is simply an irritant and not a big deal. Trump’s threat against China is also not being believed. The ‘smart money’ is inactive.”

The chart shows the machines trained to buy the dip joined the momo crowd to buy aggressively, briefly bringing tech stocks to a gain for the day. It turned out that this time, the machines guessed wrong and the rally fizzled.

The VUD indicator shown on the chart is the most sensitive measure of supply and demand in real time. It shows massive selling came in and machines reversed course after first making a mistake. This is shown by the orange color on the chart.

The takeaway here is that machines do make mistakes in judging direction, so in a short time frame, buying the dips does not always work. Of course, in a longer time frame, buying the dips has been working since 2009.

It is conceivable that if a missile fired by North Korea fell on a populated area in Japan, or if North Korea did something to test a bomb to generate an electromagnetic pulse that can disrupt the internet and the electricity grid, the buy-the-dip crowd may turn out to be wrong and the machines may make mistakes.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

The longer-term chart

Please click here for the longer-term chart of S&P 500 ETF SPY, -0.01% The chart shows the major support zone. In terms of the Dow Jones Industrial AverageDJIA, -0.10% the major support zone comes into play about 4,000 points down. There are many small support zones above the major support zone.

For market timing and proper allocation, at The Arora Report we use the adaptive ZYX Global Allocation Model with inputs in 10 categories. Right now the model is telling us that any garden-variety correction will be contained by the small support zones that are above the major support zone. However, in my 30-plus years in the markets, I have repeatedly seen that in the event of a major crisis or a major selloff, the stock market cuts through the small support zones like a hot knife through butter. Often the first stop for a bounce is the major support zone.

Buying opportunities

In case there is a massive selloff, it is likely to be a buying opportunity — barring a nuclear war. Consider keeping your buying list ready. There is a strong case for the Dow to rise to 30,000.

What to do now

The following is being reproduced here from the Morning Capsule provided every day to The Arora Report subscribers before the market open.

“It is important for investors to look ahead and not in the rearview mirror.

“Consider continuing to hold existing positions. Based on individual risk preference, consider holding cash or Treasury bills 19%-29% and short- to medium-term hedges of 15%-25% and very short-term hedges of 15%.

“It is worth remembering that you cannot take advantage of new upcoming opportunities if you are not holding enough cash. When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non-ETF); consider using wider stops on remaining quantities and also allowing more room for high-beta stocks. High-beta stocks are those that move more than the market does.”

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. All recommended positions are reviewed daily at The Arora Report.

Nigam Arora is an investor, engineer and nuclear physicist by background, has founded two Inc. 500 fastest-growing companies, is the developer of the adaptive ZYX Global Multi Asset Allocation Model and the ZYX Change Method to profit from change in trading and investing. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.

http://www.marketwatch.com/story/the-dows-first-stop-could-be-4000-points-lower-if-theres-a-real-selloff-2017-09-06