Market "Trapdoor" Just Ahead?

I'll sketch out my stock market battle plans for you in a moment.

But if you're wondering why the market suddenly became so volatile last Thursday (+5.5% intraday) and Friday (-4%) - here's the short version of the story in 4 quick chapters...

1. In recent weeks (per Bloomberg), large trading firms "bought up more than $10 billion in puts on individual stocks...a record for that group and close to the most ever by any single cohort of traders."
2. There's also a record amount of short-selling going on.
3. So when Thursday's September CPI report came in worse than expected - instead of a deeper selloff - we experienced a "boomerang effect" as all those big traders rushed to cash in their windfall profits at the same time.
4. But when a big rally comes along, what have we all learned by now (10 months into the bear market)? We sell, sell, sell - which is why Friday gave everyone such a terrible hangover.

So here's the way I see the coming week...

The market is very oversold. I don't think things can keep going like this - speaking of the extreme volatility we saw on Thursday and Friday - without something big happening.

So I expect one of two things...

Either we see a big rally to get us off these lows - which admittedly seems very unlikely at this point (but I'll point out that "unlikely" "impossible" "can't happen" are the 3 words mentioned most often at market bottoms).

Or we wind up with the "trapdoor scenario" I sketched out in a message last Wednesday.

So I'll mention the trapdoor idea here again. Just so everyone knows the potential risks - and rewards.

I note "rewards" because the idea of a year-end rally might seem like a perpetual mirage. But if the trapdoor scenario plays out - there are still potential rewards to be had (skip down deeper in this post to "Betting on the Next Rebound" for that part of the story).

The Trapdoor Scenario

The last time I saw this "trapdoor scenario" was in the 2000-2003 bear market.

If we compare the chart of today's now-infamous ARK Innovation (ARKK) ETF as a proxy for highly speculative stocks - much like the Nasdaq 100 index etf (QQQ) was back during the feverish days of the dotcom bubble...the 2 etfs are practically mirrors of each other, 21 years apart:

Here below are the same 2 charts, "zoomed in."

Both ARKK today, and the Nasdaq QQQs in 2001, mounted hopeful 4 month-long rallies before fading back to those same lows.

When that happened in 2001, the "trapdoor" sprung open, taking the Nasdaq down 26% in two weeks' time (the S&P 500 fell 12% in the same number of days).

I hate to pick on ARKK specifically, but I have important reasons for it.

On Friday, ARKK closed at an important technical level - its lowest closing price since before the "pandemic panic" of 2020.

So anyone who "bought the dip" back then in 2020 (as millions of new investors did) and "HODL'd" (held on for dear life)...has now watched his/her purchase go from being very profitable to becoming yet another loss.

When we watch big gains slowly dwindle down to a loss...that's definitely a recipe that leads folks to finally "throw in the towel" on their investments.

I don't wish such a thing on anyone - I've been there myself. But the main idea is that - from a contrarian standpoint - when enough folks finally throw in the towel on the stock market, then the market will finally be ready to mount a strong rally.

So that's why I think the activity in ARKK is worth all of us watching.

• The ETF is down 78% since its all-time highs last year.
• It remains one of the 20 most heavily traded etfs out there.
• As recently as September, it still attracted inflows of money from hopeful investors making big bets on a rebound in the most-speculative of stocks.

Lastly, ARKK's relatively smooth chart profile makes it a little easier to visually judge the main up-or-down trend. It doesn't have a huge amount of liquidity. So it doesn't have the jagged ups and downs of the S&P 500 or Nasdaq QQQs, where hedge funds and big Wall Street banks can all pile in (or out) at a moment's notice.

Betting on the Next Rebound

But we don't want to lose sight of what we're really here for...which is to make money.

Like a Civil War general (I'll leave it to you whether you want to choose to be General Grant or General Lee)...we want to choose the time and place of our battles - where we take risks, and where we do not.

That's why the goodBUYs portfolio, year to date, the portfolio is only down about 9%.

So if the "trapdoor scenario" plays out like it did in 2001...we may have an edge in betting on a strong rebound, and salvage some good gains in the last 2 months of the year.

Lastly, let's remember that bear markets are always "terra incognita"...unfamiliar land. As much as someone like me points out how one bear market 21 years ago is similar to the one we're in now...nothing is written in stone.

All we can do (as I keep saying) is try to make smart bets...

We maximize those bets for bigger gains when it looks like we're correct, and minimize those bets to limit our losses when we're wrong.

Jeff Yastine