Apparently, the markets dropped 10% in a matter of minutes yesterday because a "fat finger" trader mistakenly hit the "b' key instead of the "m" key. Fortunately orders don't trade that way and our sense is that the stock exchanges needed a "reason" for the media. Our feeling is that the system broke yesterday and we started to crash until the powers that be stepped in to keep the markets from imploding. Case in point, while we were looking to purchase various positions during the craziness, there were large spreads between the bid (sell price) and ask (buy price) one minute and all of a sudden there was no market. No bid, No ask, nothing. Stocks just don't trade like that even under heavy amounts of selling. Something happened yesterday that is not normal and shows that something is wrong with the system. We hope someone figures out what happened.
Why does this matter? Because our system is built on credibility, trust, and confidence - confidence in the process. Credibility and loss of confidence was at the heart of the financial crisis in 2008 and could become an issue once again. Psychology is a delicate animal and can turn vicious when the "real" comes to the surface.
Now from where we sit the last thing we want is for the market to crash as it wouldn't be good for anyone. However, it is within the probability spectrum and an outcome we must respect. Yesterday was a great example of "expect the unexpected".
So what does one do? The key is not to panic, but to act rationally. The worst of the downside may have already happened - emphasis on the word "may". According to reports, all of the unusual trades on the major exchanges that happened between 2:30 and 3:00 yesterday will be cancelled. This could add some stability to trading today but also means that people that panicked and sold positions yesterday will have the trade cancelled, so they could decide to sell at some point in the near future.
It's highly likely that markets will remain volatile over the coming weeks as news from Europe and currency markets take center stage.
In times of crisis and high levels of uncertainty it's better to error on the side of conservatism and position accordingly. Cash can be the great neutralizer in volatile times. While it doesn't help you when the market goes up, it doesn't hurt you when the market goes down. Plus, it's always good to have capital on hand to take advantage of opportunities. We have to remember that the capital markets will be here tomorrow and there will always be opportunities.
The good news from yesterday's free fall is that dumb money sentiment is beginning to turn more negative after several weeks of europhic numbers; while smart money sentiment is beginning to turn more positive (see recent weekly updates). This sentiment shift could be setting the markets up for a decent multi-month rally.
