The Most Important Thing to Do as the Market Teeters on the Edge of a Downtrend
Valuation suddenly matters and risk of further downside has heightened. Here's how to approach this market right now.
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The market action on Tuesday was brutal, with a strong earnings report from Palantir Technologies (PLTR) triggering aggressive selling in the technology and AI sectors. Concerns about valuations and extended technical conditions drove the profit-taking.
The key question now is whether this is just another brief but painful bout of selling or the start of a significant market top. The selling took place on 2% lower volume on the Nasdaq, suggesting there is no widespread panic, but breadth was three-to-one negative, and the selling in speculative assets such as Bitcoin (IBIT) and smaller-cap stocks was aggressive.
What is most important now is that some support forms and that there is not a series of lower lows. Downtrends build when bounce attempts fail and recent lows are undercut. The indexes closed at the lows on Tuesday, and that is now a key level. The first step to recovery will be to hold above that level and not close even lower.
In addition to watching technical conditions, it is vital to monitor sentiment shifts and the developing market narrative. The key issue that Palantir triggered on Tuesday was the valuation of the AI sector. There is no question that PLTR has been an exceptional stock and is performing at a phenomenal level, but valuation suddenly matters. There is an intensifying debate over whether the trillions being poured into AI development will deliver the payoff that these high valuations are based on.
In addition to the AI valuation debate, the Fed's uncertain dovishness, the upcoming Supreme Court hearing on tariffs, the government shutdown, employment numbers, and other economic news are also creating obstacles. The bulls are counting on positive seasonality to help offset some of these problems.
The most important thing you can do right now is to play stronger defense and protect capital. This is not the time to be aggressive and hope for a bounce. The risk of further downside is substantial, and the focus should be on avoiding losses that will have to be recovered.
The good news is that market selloffs like this punish many good stocks, which will eventually be great opportunities for patient investors. Don’t be in a big rush to buy these pullbacks. If this does develop into a substantial downtrend, many stocks will go much lower before they find support.
At the time of publication, Rev Shark was long IBIT.
