For investors, things are great when the prices of their investments are moving in an upward direction. Inevitably, though, the value of those investments will dip at one point or another. This is the nature of the market: ups and downs. A sell-off, however, is different. It is the accelerated selling of securities, including stocks, bonds, commodities and currencies, beyond the daily ebb and flow of market prices.
The ability to identify a sell-off can be an extremely reliable resource to have in a time of market uncertainty. These signals can present themselves in various forms so be prepared to analyze a number of indicators.
The unexpected has and will always be a key contributor to market sell-offs. When a company releases its quarterly earnings report, there is a possibility it can fall short of analysts’ expectations. If it’s one or multiple companies with substantially negative results, the news can trigger mass selling for that specific company or the broad market. Black Swans are another unpredictable occurrence that can upset the direction of the market significantly. Their sudden nature can eat away at the value of investment holdings extremely fast so beware as they are impossible to predict. If either of the preceding occurs, you can be sure that the downward movement will not be over in a day’s time so be prepared. (Related: Black Swan Events and Investment.)
The overall economy doesn’t come up short when it comes to information about its progress or lack thereof. Economic reports, such as Initial Claims, Retail Sales, and Gross Domestic Product, to name a few, will have a considerable effect on the performance of the market. Any substantial, negative developments will most certainly provide indication that the markets are headed down for the foreseeable future.
Commodity and currency fluctuations also have the strength to wreak havoc on investment portfolios. Rising commodity prices can be an early signal of higher costs being passed down to consumers while simultaneously diminishing companies' profits. For instance, a spike in oil prices will affect what consumers pay at the pump and what it costs for a company to ship goods. As far as currency is concerned, an upward trend in the value of the U.S. dollar can inversely devalue stock prices because it will be more expensive to buy American stocks with a higher priced dollar. Sharp spikes in commodity and currency values should be monitored carefully as they have a trickle-down effect on investment positions. (Related: Commodities that Move the Markets.)
As if the previous factors weren’t enough, technical indicators may also reveal the direction of a stock, currency or even a market index. For example, the Moving Average Convergence Divergence is a momentum indicator that can convey which direction a security or market is headed beforehand. Another commonly used indicator is the Relative Strength Index, which can determine whether a security is overbought or oversold. If overvalued, this could be a sure sign that a sell-off is imminent. Head and Shoulders Pattern is also said to be one of the most reliable indicators in determining a trend-reversal pattern, which should be employed for those using technical analysis on a frequent basis. (Related: Basics of Technical Analysis and The Four Most Commonly-Used Indicators in Trend Trading.)
The Bottom Line
Being able to spot a sell-off before it happens is an important skill to have as an investor. Adverse earnings and catastrophic events can be difficult to predict, but knowing how to handle it when they do occur is invaluable.
The overall economy can throw signals from different angles without warning, so being able to interpret their underlying messages may preserve portfolio value in a pinch. Technical indicators are plentiful, so understanding which ones can support your directional predictions may equip you for a potential downturn. While it’s impossible to consistently predict when a sell-off might occur, it is feasible to have a thorough understanding of how to analyze certain events if and when they transpire, allowing you to better protect your investment portfolio.