The tech-heavy Nasdaq 100 index fell more than 5% on Thursday, interrupting a momentum-fueled uptrend that lifted many components to all-time highs. Semiconductor stocks triggered a second selling wave in the post-market after a Bloomberg report that China plans to develop its own chip industry to counter U.S. restrictions. This news put additional weight on the index in Friday's pre-market, ahead of the monthly jobs report.
- The Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100, reversed after crossing $300 and nearly reaching key Fibonacci resistance.
- The selloff is waving a red flag, telling traders and investors to exercise risk management.
- There's no evidence so far that the downturn will expand into a full-blown correction.
China announced a multi-year program to expand the local chip industry several years ago, so the news looks more like an excuse for selling pressure than a valid reason. Even so, the decline highlights excessive euphoria and complacency throughout the market, with many issues bid up far in excess of their legitimate valuations. In turn, this has fueled a momentum game of musical chairs, in which all participants knew the music would stop, sooner or later.
The Nasdaq 100 and the S&P 500 held short-term support throughout Thursday's rout and after the jobs report, so the extent of the downside remains unclear. We've already suffered through a number of "one-day wonder" selloffs in 2020, giving short sellers just enough time to open positions before they get crushed in yet another squeeze. In addition, tops take time to form, and a single session's tape isn't enough to call an end to the persistent uptrend in place since the March lows.
However, the decline is a wake-up call to review positions and take appropriate defensive measures. This risk management strategy has two important elements. First, reduce position size and/or take profits on stocks that have risen too far too fast. You can identify these issues by looking at current price vs. 50- and 200-day moving averages. Second, place stops below all of your winners to ensure a speedy exit if the downside grows and you miss an easy exit.
Both strategies require discipline because greed blinds traders and investors to growing risk. It's perfectly natural to want your beloved tech stocks to rise into infinity, but mean reversion is the market's only "sure thing." Saying it another way, every rally eventually ends and shifts into a counter-trend that tests lower price levels until overbought technical reading work out of the system. Unfortunately, some of these "tests" will generate hundreds of downside points.
A stop-loss order – also known as a stop order – is a type of computer-activated, advanced trade tool that most brokers allow. The order specifies that an investor wants to execute a trade for a given stock, but only if a specified price level is reached during trading.
Nasdaq 100 Daily Chart (2018 – 2020)
The Invesco QQQ Trust topped out above $187 in August 2018 and sold off to a 15-month low in the $140s in December. It broke out above the prior high in May 2019, but buying interest failed to emerge, yielding choppy sideways action that crisscrossed new support into October. The index then took off in a healthy advance that reached $237 in February 2020, ahead of a decline that failed the 2019 breakout before bottoming out at a 13-month low.
The subsequent bounce completed a V-shaped pattern into the prior high in May and broke out, nearly matching the length of the first quarter decline into this week's all-time high at $303.50. The combination of round number and 2.000 Fibonacci extension prompted selling pressure that may or may not signal an intermediate or long-term top. For now at least, the decline is holding a trendline going back to the March low, telling us that the index hasn't broken any support levels.
A blow-off top is a chart pattern that shows a steep and rapid increase in a security's price and trading volume followed by a steep and rapid drop in price usually on significant or high volume as well. The rapid changes indicated by a blow-off top, also called a blow-off move or exhaustion move, can be the result of actual news or pure speculation.
The Bottom Line
The Nasdaq 100 has reversed after reaching key technical levels, but there's little evidence so far of a longer-term reversal.
Disclosure: The author held no positions in the aforementioned securities or their derivatives at the time of publication.