On August 5, a sharp spike in volatility wiped out $6.4 trillion in global market value. It sent the technology-heavy Nasdaq-100 down 13% from its peak.
And just as quickly as the losses appeared, the market is quickly recovering.
But looks can be deceiving.
I’ve been around long enough to know that sudden spikes in volatility don’t just vanish.
After all, I’ve been trading for 40 years. In that time, I’ve gone through events like the 1987 crash, the dot-com bust, and the 2008 financial crisis.
When a quick move higher follows a sudden plunge… it can be a trap.
You may have heard phrases like a “dead cat bounce” or a “sucker’s rally.” Those terms pretty much sum it up.
The market likes to draw in unsuspecting buyers before reversing lower again.
And a look at history can provide a useful road map of where things could be heading next.
Because right now, I’m seeing striking similarities to a past surge in volatility.
And there are a couple of key things to watch to make sure you don’t get drawn in at the wrong time…
Retesting the Lows
Two weeks ago, the sudden surge in volatility – and the sharp drop in the stock market – seemingly came out of nowhere.
But it’s not without precedent… just look back at 2015.
The Invesco QQQ Trust Series 1 (QQQ) was going through similar circumstances to what we’re seeing now.
That includes a July peak followed by a bumpy August.
Back then, the CBOE Volatility Index (VIX) soared 249% in three days.
QQQ fell 14% into a correction around August 25. Take a look at the QQQ chart below from 2015:
After a quick drop to “1,” QQQ rallied toward the 50-day moving average (MA, blue line) at “2.”
That was the sucker’s rally.
Following that test of the 50-day MA, QQQ fell and retested the low at “3.” That was a 7% drop in eight days.
Back then, the quick rally fooled many traders into thinking the worst was over.
But anyone who jumped back in too early got walloped.
So you need to be paying attention today.
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Another Sucker’s Rally in the Making?
When volatility levels spiked higher two weeks ago, QQQ was down 13% from its July peak.
But the price is rapidly reversing higher… it has surged 9% in eight days.
And that’s bringing QQQ back to a key level to watch in the chart below:
QQQ is testing the 50-day MA at the blue line (“1”).
At the same time, the Relative Strength Index (RSI) in the bottom panel is at 56 (“A”).
For RSI, the 60 level often serves as an overbought level during a downtrend.
In the 2015 sucker’s rally, for example, the RSI stayed below 60.
It’s remarkable how similar QQQ is trading compared to the meltdown in the summer of 2015. That includes the test of the 50-day MA from below.
And while there’s no guarantee that the surge we’ve seen will slump again, I would be wary of another sucker’s rally.
If QQQ turns lower after the test of the 50-day MA, a retest of the August lows is a real possibility.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict