Market Leaders Leading Towards Capitulation

Hey 5-Star Trader,

Last Friday I joined CNBC to discuss how the Nasdaq market-leading stocks would determine the direction and they have led the way lower, here is the full breakdown or something

The image below sums up the reason why the current bear market in the Nasdaq could potentially be catastrophic. After a 13-year long bull market, especially on in which was filled with peak exuberance near the middle to end of 2021, this chart demonstrates why there is the potential for this market to continue heading much lower.

Let’s talk about margin debt and what kind of impact this could have on the market from here on out. Margin debt is debt that traders and investors can take out in order to buy stocks. When the market began rallying in an almost unbelievable way off of the 2020 lows after the COVID crash, a record number of new traders and investors entered the market. Many of those were able to purchase stocks on credit, otherwise known as margin. 

Now, buying stocks on margin isn’t the worst thing – as long as the value of your positions continues going higher. However, it becomes problematic when those positions begin losing value, especially if and when they were purchased near market highs, which also happened to be around peak exuberance (mid to late 2021). 

Check out the graph below:

Now, when this correction began, it began much like the Dotcom bust. First, some of the recent IPOs and former COVID darlings started taking hits when it became clear that they weren’t measuring up against the forward projections made in times of lockdowns and a changing world.

Let’s talk about Peloton (PTON) for example. 

Peloton was one of the most profitable tickers for me throughout 2020. Now, I never actually owned the stock. I simply traded the massive rallies, many of which were based on short squeezes, on a regular basis. This stock has gone from an IPO open of around $27 to an all-time high of $171, and is now back down below its opening IPO price at $14 a share. 

Now, some may say, 

“That was obvious. Who wants to pay a couple grand for a glorified coat rack? Gyms are open now, the pandemic is abating…etc.” 

But, it’s not just about this one ticker. Because it’s not just Peloton that has made a Dotcom crash style move. Take a look at any of the stocks that have been on my Earnings Destruction list this quarter. 

The Dotcom Stocks of 2020 include:

  • Wayfair (W)
  • Beyond Meat (BYND)
  • Netflix (NFLX)
  • Chewy (CHWY)
  • Roku (ROKU)
  • DocuSign (DOCU)
  • Teladoc (TDOC)
  • Sea Limited (SE)
  • Upwork (UPWK) 

…and more!

The problem right here and now is, is that this Dotcom style move has begun to permeate not just former COVID darlings, but now it’s hitting large-cap FAANG stocks. 

Remember back when Facebook, Apple, Amazon, Netflix, Google, Microsoft, Tesla, and Adobe all lead the market? Where they went, the Nasdaq would follow. 

The problem is, earnings destruction has taken down the likes of Facebook, Netflix, Google, and Amazon. Despite strong earnings, ADBE has almost been cut in half. 

That leaves Apple, Microsoft, and Tesla as the last soldiers standing. The problem is, they can’t hold up the Nasdaq on their own. And, they are also starting to crack. 

So, where do we go from here? 

Kelly Evans and I discussed this on The Exchange on CNBC on Friday, May 6th. Check out the segment here!

Specifically, we discussed the major price rejection on Thursday after Wednesday’s massive rally post-Fed. While initially the short squeeze higher was fun to trade, the fact that it didn’t last was a massive red flag. 

Why? The moves in AAPL, TSLA, MSFT, and NVDA post-Fed are very harrowing because they continued to roll and tank to an extreme amount immediately after the Wednesday rally. At this juncture, the market really needed a substantial bounce back, backed by these core, leading stocks.

At this juncture, if we don’t get any kind of bounce back, which I think seems unlikely, that is really where the sell-off gets bad. We still haven’t seen capitulation, as so far we have experienced more full risk-off days with regular selling the entirety of the day. This is demonstrated based on the continual negative $ticks, which means we have more selling than buying, a falling volume spread, indicating again more volume selling than buying, and steady selling throughout the day, versus a hard flash of selling that capitulates. 

It’s when the core, large-cap stocks tank that we have the major risk for capitulation and margin calls. 

Why? Let’s go back to the image above. Investors everywhere have bought stocks on margin, to the tune of billions of dollars. While many have certainly invested in the former COVID darlings and have taken major hits on these investments, the largest amount of market cap is found within the market leaders. These market leaders are the few companies that have managed to cling to lows, have crushed earnings, and all eyes are on them. These three are Apple, Microsoft, and Tesla. 

When I’m trying to determine which direction the market will go, I always have my eye on these market leaders. Even if you don’t day trade, watching them on a 5 or 15-minute chart intraday can give you a heads up when the market begins to shift. They lead the Nasdaq higher, but they also lead it lower.

Now, Nvidia is a bit of a tricky one, because it’s taken the biggest hit out of the stocks I mentioned. But, it still leads semiconductors. And, as of right now, it’s getting trashed to the downside, leading the VanEck Semiconductor ETF (SMH) even lower. Semiconductor companies are critical as these high-growth stocks have received a lot of speculation, and with that, a lot of investment. Nvidia has been leading the way lower, and at this juncture, the moves in Tesla, Apple, and Microsoft are all leading lower as well.

Without the strength of these companies, and without buyers feeling the confidence to come in and buy at these lows, the path of least resistance remains to the downside. 

Microsoft broke my key support zone at $270. After this, my next level is $260, and then $250.

Apple is clinging to support at $150. A break at this zone could easily equal $135-140. 

Tesla broke $800. A continued move lower could go to $600-700. 

If (when) these stocks continue to tank (I do consider being down -7% as is the case for Tesla), the major risk here is that the bleeding of the Dotcom stocks of 2022 will bleed into our large-cap favorites that are the backbone of the Nasdaq. They are the last soldiers standing, and if they fall…that is when margin calls will certainly speed up, and capitulation will come calling. 

At that juncture, I wouldn’t be surprised to see the S&P and Dow enter a bear market along with the Nasdaq. I would also expect to see the Nasdaq fall to around 10,000. 

Now, that’s not to say we will go straight there. Remember, on dead lows of the year with a put/call ratio above 1.0, a face-ripping short squeeze rally is possible at any time. Problem is, the catalyst for capitulation (margin calls + market leaders breakdown) is much larger than any catalyst for a short squeeze at this moment. 

If you find yourself thinking, ‘Surely, it can’t go lower…’ just take a look at any of the charts I’ve listed above in the ‘Dotcom Charts of 2020.’ It sure can, and it will.

-Danielle =)

Want to hear from Simpler Trading’s founder, John Carter? On Saturday, May 14th, from 12-4 PM central, join John as he talks about the current market and how to use some free tools to keep up with the market. There’s been insane volatility lately and John will cover what it all means and how you can take the emotion out of it and rely on your charts for market direction. You can get the class for $97! Click HERE to learn more.

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