Selloff is the rapid selling of securities such as stocks, bonds, ETFs, commodities or currencies. A selloff may occur for many reasons, such as the selloff of a company’s stock after a disappointing earnings report, the departure of an important executive or the failure of an important product. Markets and stock indexes can also selloff when interest rates rise or oil prices surge, causing increased fear about the energy costs that companies will face. selloffs can also be caused by political events, or terrorist acts.
All financial trading instruments have selloffs. They are a natural occurrence from profit-taking, short-selling or portfolio turnover. Healthy price uptrends require periodic selloffs to replenish supply and trigger demand. Minor selloffs are considered pullbacks. Pullbacks tend to hold support at the 50-period moving average. However, when a selloff continues on an extensive basis, it can be signs of a potentially dangerous market reversal leading to a correction or a crash.
Corrections tend to be more aggressive, usually testing the 200-period moving average. A correction is generally a 10% or greater decline in a company’s stock or a market index from its recent highs. The death cross is a popular selloff signal in which the daily 50-period moving average forms a crossover down through the daily 200-period moving average. However, the distinction between a correction and a bear market is clearly defined.
Corrections and Bear Market Selloffs
When a selloff resonates throughout the financial markets for an extended period of time, it can trigger a bear market. A bear market is generally considered to be a decline of 20% or more from a security or markets recent most recent closing high. Since 1929, the domestic equity markets have experienced 20 bear markets, according to Yardeni Research. The average bear market experiences a 35% selloff from the highs and lasts an average of 16 months. Bear markets are defined by two distinguishing characteristics. The selloff must remain at least 20% from the highs for a duration of at least two months. Anything less is considered a correction. At the beginning or 2016, the markets were dangerously close to a bear market, as the Standard and Poor’s 500 (S&P 500) index fell negative 18% in the first two months of the year. However, the rebound back to break-even price levels distinguished it as a correction, as it failed to hold negative 20% losses for more than two months.
Panic selling is a wide-scale selling of an investment which causes a sharp decline in prices. Specifically, an investor wants to get out of an investment with little regard of the price obtained. The selling activity is problematic because the investor is selling in reaction to emotion and fear, rather than evaluating the fundamentals. Most major stock exchanges use trading curbs to throttle panic selling, providing a cooling period for people to digest information related to the selling and restore some degree of normalcy to the market.
Causes of Panic
The panic is typically the fear that the market for a particular industry, or in general, will decline, causing additional losses. In the event of panic selling, the market is flooded with securities, properties or commodities that are being sold at lower prices, in which further stumbles prices and induces more selling. Common causes of panic selling are:
– High speculation in markets (e.g. Dubai’s Housing Crash in 2009)
– Economic instability (e.g. The Financial Crisis in 2008)
– Political issues
There have been two bear market selloffs in the new millennium. The S&P 500 fell 58% during the bear market of 2000 to 2002 during the technology bubble. The second bear market selloff occurred during the housing bubble and global financial meltdown from 2007 to 2009 as the S&P 500 dropped 57%. The average bear market occurs every 3.4 years. Markets have been in a bull market for nearly double the average figure. It should also be noted that a truer indication of an economy is evidenced in the bond market.
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