After the surprise dip of 666 points on 2 Feb 2018, Dow Jones Index dropped another 1175 points on 5 Feb 1018, there is total of about 7% correction over the last 2 trading days, strong enough to drive short term traders (who long) out of the game temporarily.
Those algorithmic trading tools which follows the TA rules, when critical short-term support is broken, would rush to find the nearest exit to sell down with high volume recorded, adding to the power of market correction in a short time. There are over 70% stock trading in US is done by robot or algorithmic trading, mostly are trend follower, therefore when there is a flash crash, the robots will follow one another to exit from the stock market or even start the shorting process.
The 7% stock market correction is overdue, especially for US and Hong Kong stock markets which have been over-heated in the past few months. Macroeconomy and stock market are connected loosely, when the fear emotion is over (intra-day VIX was 50 but subsiding quickly), fundamental will have influence over the technical again, before the greed emotion takes over again.
There is nothing wrong for short to medium term traders to take profits of last few months as this was the exit strategy. After all, US was at very high Optimism (over 90%), any potential risk could be the next black swan, resulting in the global financial crisis. In year 2000, the dot com bubble was simply too large, price over value, therefore a high optimism stock index, itself can be a potential crisis because when most people are profiting from the bullish market, any shake would change the greed into fear.
Trading in a high optimism stock market is as if walking on a layer of thin ice. Sometimes it could be a false alarm (wolf is coming), sometimes it could be a real crash of ice and stock market. Therefore a systematic and disciplined trading plan is needed.
Investors would want to wait for the global financial crisis to come ASAP to buy low for strong fundamental stocks. However, political economy could add more complexity and traders could buy low again in short term if it is only a regular correction. Therefore, patience is crucial for investors.
Allocation of funds (cash vs stock) is critical to manage the emotions for a trader and an investor. When one invests too much at high optimism, the self control is weak. It is fine to cut loss in a trading market when the future price trend is against the earlier assumption. The worst is a mismatch of personality with strategy, eg. entering as a short term trader for a quick return, ending up holding as a long term investor when stock market is confirmed a crash.
This Chinese saying is a good summary of strategy at high optimism stock market:
Learn to match the stock trading or investing strategy with own personality. Attend free investment courses by Dr Tee.