Did Last Week Mark the Near-Term Panic Low in the DJIA?

According to Web MD, some of the symptoms of panic attacks include “a racing heart, a sense of terror, and feeling unreal or detached from your surroundings” among others. While not nearly as serious as an actual panic attack, last week’s stock market rollercoaster likely caused most traders to display some of these symptoms last week. At one point last week, the widely-followed Dow Jones Industrial Average (DJIA) index had fallen over 600 points in just a 48 hour window to hit an 8-month low under 15,900

Perhaps heeding Warren Buffett’s timeless advice to “be greedy when others are fearful,” more level-headed traders stepped in at that point and the DJIA has since bounced back over 700 points from last week’s panic low. Now, traders the world over have the same question on their minds: Did last week’s low mark a near-term bottom in the market, or have we just seen a brief countertrend bounce?

One of the best measures of fear and panic in the stock market is the Volatility Index (VIX), which measures the volatility embedded into the prices of short-term options. In general, a rising VIX shows increasing expectations for future volatility, or in layman’s terms, more fear. As the chart below shows, the VIX spiked to a 3-year high above 30  midway through last week. However, by the end of the week, the index had fallen back to just 22, creating a large weekly Bearish Pin Candle*, or inverted hammer pattern, on the chart. So far this week, it has continued to drop all the way down to 17, in-line with the average reading over the last few years. The massive, short-lived spike in the VIX suggests that we may have seen a panic, capitulation bottom in stocks last week.

Source: Stockcharts.com and FOREX.com

Focusing more directly on the DJIA itself, we can see a similar pattern in reverse. After dropping a 9-month low midweek, buyers stepped in late in the week to create a big Bullish Pin Candle*, or hammer pattern, on the weekly chart. This pattern shows a dramatic shift from selling to buying pressure and often marks a near-term bottom in the market. Beyond the candlestick pattern, stocks also found support at bullish trend line support off the Great Financial Crisis low around 15,800, while the weekly RSI indicator remains within bullish territory (>40).

Taken together, the charts of the VIX and the DJIA suggest that we may have seen a near-term bottom last week and that the DJIA may continue to rally back toward the 17,000 level in the coming weeks. While we maintain some of our longer-term concerns with equities, the case for a short-term bounce in US stocks is strong as long as the DJIA stays above last week’s panic low at 15,850.

For more on how the recent volatility in US stocks may spill over into the forex market, see our special guide, "Trading FX in Times of Stock Market Volatility"

*A Bearish Pin (Pinnochio) candle, or inverted hammer, is formed when prices rally within the candle before sellers step in and push prices back down to close near the open. It suggests the potential for a bearish continuation if the low of the candle is broken.

*A Bullish Pin (Pinnochio) candle, also known as a hammer or paper umbrella, is formed when prices fall within the candle before buyers step in and push prices back up to close near the open. It suggests the potential for a bullish continuation if the high of the candle is broken.

Source: FOREX.com