In recent years one of the most interesting technical phenomena in the stock market is the tendency toward V-shaped moves.
Although the selloff in the fourth quarter of 2018 went lower than many expected, the recovery since then has been another classic example of a V-shaped bounce. The market has gone nearly straight up after it hit a low on Christmas Eve. There were no retests or significant pullbacks for months.
Stocks dipped again this past Monday on fears of a trade war but since then we are seeing another example of a V-shaped bounce. This one is on a much smaller scale than what has occurred since December but the dynamics are much the same.
The conventional wisdom of technical analysis is that markets don't go straight back up. The theory is that when market players suffer sharp, sudden losses, they are inclined to look for exits into strength. That propensity to escape an uncomfortable situation is what prevents the market from going straight back up.
The technical term that is used is "overhead resistance," which is nothing more than the point where a large number of market players will break even. If they can escape from a stock that has caused them some worry without a loss then they are likely to do so.
That is the theory but for a number of years it hasn't been the case. Once the bounce starts the market keeps running higher. Overhead resistance is meaningless and rather than worry about being caught in another pullback, market players seem much more concerned about missing out as the bounce goes higher.
There are two reasons for this inclination toward V-shaped bounces. The first is that they have become a staple of the computer algorithms that drive the bulk of the market. These programs are designed to exploit typical human emotions and going straight back up is an excellent way to do that. While the poor humans are wrestling with the issue of whether something of consequence has shifted in the market, the machines are running straight up and causing great anxiety.
The second reason that V-shaped bounces have become more common is that they have been successful. Market players adapt quickly to patterns and this one is very obvious. V-shaped bounces are now self-fulfilling because they are no longer viewed as being unusual.
It is helpful to understand this phenomenon so that you don't spin your wheels trying to fight it. Normally these runs come to an end with a intraday reversal and a poor close but their nature is to last longer than seems reasonable.
Poorly positioned market players helped to keep the bounce going Wednesday and they are feeding it again Thursday morning. There hasn't been any major improvement in fundamentals since the trade negotiations broke down but this is technically driven action, not fundamental.
The best thing you can do in this environment is to understand and appreciate the V-shaped bounces. You don't have to chase it but you do have to worry about the wisdom of trying to fight it. The V-shaped bounce is at odds with traditional technical analysis and that is what makes it a mighty force.
We have a gap-up open Thursday morning although there isn't any obvious positive news to drive it. Market players are now more worried about missing out on further upside than they are worried about a failed bounce.