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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Thursday, April 23, 2020

1. Stocks sell in mid-day on bad news from Gilead Sciences

2. Why the price action on GILD shares matters

3. Knowing when to sell

Market Moves

U.S. stock indexes fell sharply in a ten-minute span after a singular news item broke. The company that generated this bad news paid a steep price also. While it is not unusual that news from one company ends up moving the entire market instantly, it is very unusual that the entire market has its hopes pinned on a single news item such as this one about a COVID-19 treatment. When such a market tremor occurs, chart watchers find it very useful to observe the aftershocks carefully to better comprehend clues to prevailing investor sentiment.

News broke this afternoon that a potential treatment for COVID-19, one based on a drug from Gilead Sciences (GILD), was not as effective as previously thought. The stock actually halted at one point. Naturally the shares tumbled lower, but because it wasn't just GILD shares that fell, it was clear that investors everywhere had something riding on this news.

The benchmark S&P 500 index (SPX) fell a little over one percent (see chart below), thus putting a number to how much people had imagined that such a treatment would be worth towards repairing the damage to the economy. Considering that stock indexes closed near their lows for the day after that news, the impact was significant and may extend for a few days.

Why the Price Action on GILD Shares Matters
What this event showed was that so much of the market is connected to the pandemic and its economic effects. It appears that few other factors matter half so much right now. GILD's initial drop in price was about eight percent, though within a few minutes almost a quarter of that had been retraced. The closing price for GILD shares was quite close to this retracement level showing that, despite the company's objections, investors remain disappointed.

This matters quite a bit because investors' decisions are strongly influenced by confirmation bias. This is the term from behavioral psychology that explains how it is that investors form an opinion first, and then go looking for information to support it as they act. If information comes along that actually changes their existing opinion, that can have a significant effect on market trends. In this case, it could lead to investors giving up hope for a quick recovery.

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Knowing When to Sell

Some shrewd, or lucky, investors bought up shares within the past three weeks and are feeling pretty good about their positions right now. But do such investors have a plan? The most common mistake any investor makes about riding out a bear market is not having a plan to protect their capital. If the bear market resumes, the loss to their capital can be catastrophic.

The charts below show two examples of methods for setting stops on shares of Apple (AAPL), assuming an investor bought the shares favorably in recent weeks. The first chart uses something known as a Chandelier Stop based on a volatility measure called the Average True Range (ATR). This method calculates how much the stock has moved in its intraday range over the last month, and subtracts a multiple of the ATR from the most recent swing high in the price.

The second shows an example of a similar stop calculation (courtesy smartstops.net) that includes a proprietary measure for adding in extra volatility into the stop. This means the stop may actually move down a bit at some times, in an effort to not get stopped out by a single trade. This method has actually been shown to be superior to the first, though fewer people know about it or use it.

The Bottom Line

Stocks made a sharp drop when news broke that the drug trial for a COVID-19 treatment wasn't going so well. Looking closely at the aftermath, chart watchers can see that investors have lost some of their enthusiasm for a rebound. Based on that outcome, investors still in the market right now might do well to find a plan for protecting their capital.