By: Montana Timpson
Sometimes, market sell-offs act as corrective mechanisms for overly bullish markets — other times, sell-offs serve as catalysts for bearish price drops and negative investor sentiment. Sell-offs can focus on specific industries or individual assets and, on the grandest scope, even encompass entire markets. Here’s what every professional trader should know.
A sell-off refers to downward pressure on the price of a security accompanied by increasing trading volume and falling prices. In contrast to a market rally, a sell-off occurs when a large volume of securities is sold in a short period of time, causing the price of a security to fall in rapid succession. A market sell-off can occur in any traded asset and may vary in scope.
On a macro level, sell-offs can encompass the entire market at once, present during events like stock market crashes; the term “market sell-off” typically refers to when investors sell assets across an entire market. On a smaller level, sell-offs can occur more narrowly, applying only to sectors, industries or individual assets.
Sell-Offs’ Price Effect
As traders sell their securities quickly, the prices of those securities tend to drop equally quickly. As more shares are offered than buyers are willing to accept, the decline in price may accelerate as investor sentiment shifts to pessimistic.
Causes of Market Sell-Offs
Any number of factors can trigger a sell-off, from breaking news to varying results of earnings reports.
Negative news stories (catalyzed in part by the mass, global communication channels that social media and the Internet provide) are one primary cause of sell-offs in the market, as investors believe that the earnings of the company in question will be severely negatively impacted. One of the starkest examples in recent economic history was 2010’s British Petroleum (BP) 50% sell-off, in which the BP’s shares plummeted following the Deepwater Horizon oil spill. In addition to negative sentiment in response to the crippling environmental impacts, investors feared fiscal losses as BP faced potential fines and legal consequences — which eventually cost the company a quarterly loss of US$17 billion in July 2010.
Disappointing earnings reports, higher-than-expected inflation reports and pessimistic gross domestic product (GDP) growth rate forecasts are all factors that can contribute to market sell-offs, as well. When a company releases its quarterly earnings report that falls short of analysts’ expectations, for example, the news can trigger mass selling for that specific company or the broad market, if it’s multiple companies with substantially negative results.
Establishing the Severity of Market Moves and Sell-Offs
When looking to trade a market sell-off, there are a few key strategies for categorizing the severity of market moves which can help professional traders establish potential positions to take.
One standard practice in determining a severe sell-off is identifying price movements below lower bands in technical analysis charting. Bollinger Bands, Keltner Channels and VWAP bands can all serve this function. An even simpler similar strategy is to use standard deviation; plotting standard deviations around a linear progression line is a method popular with mean reversion traders, in particular.
Sharp rises in the VIX can also serve as a strong indicator of market sell-offs, and perhaps the most straightforward indicator of all is explicit percent decline in stock price (for reference, a bear market is traditionally defined as such when a market experiences declines of anything above 20%).
Trading a Market Sell-Off
Short selling, put options and inverse ETFs^ are some of the ways in which investors can make money during a bear market as prices fall.
It’s important to note, however, that systematic and unsystematic risk are inherent in trading a sell-off. To help mitigate threat, many professional investors choose to adopt risk management software to help automate the risk analysis process and manage risk exposure across markets and asset classes in real-time.
Risk management is a crucial process used to make investment decisions involving identifying and analyzing the amount of risk involved in an investment, and either accepting that risk or mitigating it. The Lightspeed Risk Suite, for example, is a collection of risk management applications that allow users to monitor profit, loss, halted trading symbols and real-time trading activity.
For more information regarding the Lightspeed Risk Suite, contact a member of our team at [email protected]. For more professional trading insights, check out Lightspeed’s Active Trading Blog and register now for our next live webinar.
^ Inverse ETFs can carry an elevated level of risk, click this link to read more: https://www.sec.gov/investor/pubs/leveragedetfs-alert.htm
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