Buy The Dip Versus Sell The Rally

Stock market volatility has become ridiculous …

… which is exactly what we should expect at this point in the cycle.

The longer a bull market lasts, the larger two groups of traders become:

BTFD
First and initially most numerous are the buy-the-dip traders who have spent their entire investing lifetimes in a market that always recovers. Buying every drop has, as a result, produced massive and consistent gains. A case in point is Apple, which is one of the great investments of all time, but sometimes also one of the scariest. In late 2018 it fell by 29%, and in early 2020 it fell by 46%.

Millions of weak hands dropped this stock during those corrections, to near-universal regret. The people who held on, meanwhile, feel like geniuses. But both groups learned the same lesson: Price declines are temporary and are therefore buying opportunities.

STFR
While the buy-the-dip army is expanding in both numbers and conviction in a bull market, a smaller group is coalescing around the premise that the good times have gone on way too long and will, at some point, offer a “Big Short” chance at life-changing money for the brave contrarian. These “sell-the-rally” traders take their cue from more distant history like the Great Recession, when a bunch of perfectly buyable dips culminated in a brutal crash that torched spirits and bank accounts around the world.

Bull markets end when the sell-the-rally population gets big enough to control the action. And – the point of bringing this up now – what precedes this regime change is generally a tug-of-war between more-or-less equal sides in which one knocks the market down and the other picks it up, over and over, resulting in today’s nonsensical manic depression.

Also crucial: Buy-the-dip thrives when money is easy enough to leave the rich with more than they need for conspicuous consumption. Their excess cash flows into financial assets, putting a wind at the back of stock prices. Buying the dip makes complete sense then.

Sell-the-rally dominates when the money spigot is turned off and the rich are forced to sell stocks to maintain their lifestyles.

Where are we now? In the early stages of the latter phase. As the world’s central banks respond to rising inflation with tighter money, the amount of free cash in the system is shrinking, bringing the optimists and pessimists into a rough balance. What comes next is both predictable and fun for long-suffering shorts.

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