Was Today’s Stock Market Rally a Fakeout?

This morning was an absolute bloodbath in the stock market.

But around noon central time, the market began ramping higher, staging an epic rally to close green on the day despite being down significantly.

Apparently, people dumped stocks at the open, but dip-buyers were there to scoop them up.

Yahoo Finance noted that the Nasdaq was down almost 5% at one point today but finished up 0.6%:

Stocks clawed back losses on Monday as investors looked ahead to a busy week of corporate earnings results, economic data and a Federal Reserve monetary policy-setting meeting after an already volatile stretch of trading. 

The Nasdaq Composite ended in slightly positive territory after dropping 4.9% at session lows. And earlier, the S&P 500 was off by more than 10% from its record closing high from Jan. 3 before recouping declines. The Dow recovered losses of more than 1,100 points to end nearly 100 points higher.

Expectations for tighter financial conditions out of the Federal Reserve this year have served as one major factor weighing on equity prices, especially for highly valued stocks that had benefited from the easy financial conditions and high liquidity environment the Fed had contributed to since 2020. 

This week’s Fed meeting, with a new monetary policy statement and press conference from Federal Reserve Chair Jerome Powell on Wednesday, is expected to produce virtually no immediate changes to policy. However, as the Fed looks to rein in inflation that has ballooned by the most in four decades during the pandemic-era recovery, this meeting will likely set the stage for the Fed to indicate it is nearing the start of interest rate hikes and has been further contemplating rolling off assets from its nearly $9 trillion balance sheet.

However, despite the massive rally in stocks that took place today, futures for tomorrow are down quite significantly. As of the time of this blog post (9:30pm central), Nasdaq futures are down 1.61%, S&P 500 futures are down 1.14%, and Dow futures are down 0.81%.

Are investors already preparing to fade the rally? It’s possible.

It’s possible that the dip-buyers who stepped in to turn the markets around today were short-term traders who don’t plan on sticking around to see how this all plays out. I mean, you had stocks this morning that were already significantly oversold down an additional 4%, 5%, 6%–some stocks were even down 10% or more by midday today. That’s an opportunity to make some very handsome short-term profits.

But with futures already sharply lower for tomorrow’s open, it seems like it really was predominantly short-term buyers and daytraders who stepped in today to buy the dip. They bought at the lows, watched the market ramp spectacularly into the close, and then cashed out. That’s what it seems like to me, although I could be wrong. I try not to speak in absolutes when it comes to the market because it’s impossible to be certain on what the market will do.

An interesting thing I noticed while reviewing the stock charts is the candlestick we recorded today was quite ominous. Have a look:

For those who don’t understand how candlesticks on stock charts work, I’ll give a brief explanation.

Red means the market closed lower that day, green means the market went up that day. It’s based on where it closed the day before.

The fat part of the candle is the difference between the open and the close. The thin “wick” of the candlestick is how high or low the market went on a given day in between open and close. It’s easier to explain with a diagram:

The candlesticks tell you basically everything you need to know about what the market did on a given day, as long as you know how to read the candlesticks.

Traders have identified patterns in the candlesticks, and interpret quite a bit from them, to the point that many of the candlesticks patterns you’ll see on the chart have names that tell traders what is likely to happen in the future.

What we saw today was what is called a “hammer” pattern:

You can see that the market opened lower, went way down, but then rallied to finish higher, almost at session highs.

What does the hammer pattern tell us is likely to happen in the future?

Well, hammer candlestick patterns are generally signs of a reversal in the prevailing trend of the market.

In this case, it would indicate we’re due to see a bounce in stocks soon.

But here’s the issue: often these hammer patterns are false hope signs, and the rally that follows is quickly sold off, with the market then heading down to new lows.

Look at what happened in late February 2020, when the markets were in freefall as the Covid-19 pandemic began:

The hammer candle (circled) did mark a reversal in the market back then, but only a very brief one, and it was quickly followed by an even more vicious and brutal selloff over the next few weeks.

I think it’s possible–probable, even–that markets ramp over the immediate near-term (like the next week or so) just given how incredibly oversold stocks are right now.

But it might be a false hope rally. That’s the feeling I get. It might get sold hard resulting in new, deeper lows for the major indices.

Just a thought. It’s really impossible to predict what’ll happen, that’s the vibe I’m getting right now. It just seems like there’s a lot of panic and fear out there dominating the market, and that people are going to use any bounce as an opportunity to sell and get out.

Think about it: If you’ve been holding stocks for the past few weeks amid this selloff, and you haven’t panic-sold yet, you probably either believe this is just some short-term volatility, or you are waiting for a bounce in order to dump your stocks. Waiting for a bounce allows you to recoup some losses you’ve sustained over the past few weeks instead of selling at the bottom.

I have a feeling the next rally in the market gets sold and causes stocks to careen even lower.