Short answer: Too early to tell.
So what happened? Markets run ahead of themselves (worldwide with the exception of Australia) and finished in a parabolic advance similar but not quite as extreme as bitcoin. Parabolic advances are unsustainable and will eventually break. The trigger was a sell off in bonds after strong employment numbers in the US giving fears inflation will pick up faster than previously anticipated. T-Bonds (30 year US government bonds) and 10 year T-Notes have recently peaked having completed a Head and Shoulder Top (T-Bonds) and a Double Top (T-Notes) with a classical charting minimum target indicating further substantial falls in bond prices, i.e. rise in yields. Rising yields, all other things being equal, will lead to lower share prices. So combine a parabolic share price advance with a bond sell off and we get some collateral damage. The Dow Jones fell a record number of points, the highest in the history of the Dow, but the percentage drop (and that’s what matters) was only the 25th worse drop since 1960 with the October 1987 crash (I remember all too well) being the worst. Volatility was historically extremely low and we didn’t have a correction since 2016 so a correction is / was overdue. A 10 % correction (that’s the usual definition) would bring the Dow / S&P 500 / NASDAQ down to pretty much current levels where a long term up sloping trend line should act as support. So in the short term I would expect that some support would kick in soon and bargain hunters would come in.
Now it gets interesting as it all depends how the market reacts after the bounce. It could well be a “dead cat bounce” on low volume, barely meeting previous index highs, with renewed selling coming in and forming a high which is lower than the previous high. If this happens more signs of a top will appear. However, it is also possible, even likely, that the market just needs a bit of a rest after a heavy run. The US economy is sound, consumer confidence is good, company earnings grow and the Trump tax cuts will increase those earnings even further (although we don’t know exact numbers quite yet). Inflation is picking up but at this stage nobody fears runaway inflation. Interest rates will go up (and should go up from distorted artificial quantitative easing lows) but the market still believes we have rates lower for longer. So there is a good chance that the bull market isn’t quite over yet and there is more to come (although the air starts getting a bit thin at these levels). So it all depends (don’t you hate this kind of answer?) but this is what we traders say all the time (only economists are worse…).
So how do we trade this insight? Well, we just follow our system. We get out when the initial stop is triggered, no matter what, come hell and high water! We tend to use a 8 % close only stop from entry. We also get out (one of our options) if our position reaches a 20 % profit target (unleveraged). Longer term investors should get out if and when your stock position trades below a flattening or even falling 200 Day Simple Moving Average. As a middle of the road exit strategy I quite like giving the market plenty of room to wiggle until the 20 % profit target is reached. Once this happens I use a volatility based trailing stop so that a very strong stock advances further and I get out if the market closes below our trailing stop.
During the current sell off our model portfolio took a few profits (yes, profits) on the way down. We obviously, as trend follower, had to give back some unrealised profit but most of our positions are still in the black and the initial stop is still quite a bit away from current prices. If the market bounces we should be able to keep most positions. If it doesn’t, well, we take the odd small manageable loss and this is not the end of the world, Hey, we had a good run recently.
For my liking trying to guess a top is futile. My solution is to just follow your system, ignore the chatter of the market pundits, stick to your rules and let the chips fall where they fall. The market is going to do what the market is doing to do if you watch it in real time or not and if you worry or not. So why worry, just stick to your system and enjoy the ride.