…Traders define dips in percentage terms. A 5% dip is a pullback. A 10% dip is a correction. That means we expect to see buyers appear when prices fall 5% or 10%. In the recent sell-off, that’s exactly what happened and that could set up a rally that will last for months as fund managers continue putting cash into stocks. Here’s why.
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The chart below shows the S&P 500 Index with some important technical levels. Notice that the price bounced off the 5% pullback line and again off of the 10% pullback line.
…Traders were ready for a pullback and, from the chart above, it looks like they were waiting for the pullback to buy. Skeptics might say this is a coincidence, and it might be, but the fact is, we all knew the uptrend had lasted a very long time (Prior to the decline, the index had gone more than 400 days without a 5% pullback). We also all knew prices couldn’t keep going up forever. Many traders expected a pullback or a correction.
Putting New Cash Into Stocks
Rising prices don’t stop money from coming into the market. Investment managers at pension funds and other large funds receive cash to invest all of the time. Since they are paid to manage stocks, that cash needs to go into the stock market. They might be able to hide it for a time, but eventually, they need to buy stocks, so many managers need a plan to put new money to work. They decide, in advance, which market conditions triggers their buying. Many decide they’ll buy after a 5% pullback or a 10% correction. When prices started falling, the chart shows we saw buyers rush in. There was a stampede into stocks after that 10% correction.
We don’t know with 100% certainty what’s next but we know cash came off the sidelines in the market decline [and] that could set up a rally that will last for months as fund managers continue putting cash into stocks now that they’ve had a 10% correction.
In other words, the fact that prices fell relieves the concern that the bull market is getting old. Now it’s time for the next bull run.