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How to Spot a Sell-Off in the Stock Market Before It Occurs

Ade Hennis - Author
By

May 24 2022, Updated 9:01 a.m. ET

While sell-offs are often bad for a company’s stock, they can provide great buying opportunities for investors. What are the signs of a sell-off before it occurs?

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When a sell-off occurs, it’s best to not panic and sell your shares immediately. Follow your investment strategy and see what's causing the sudden price drop.

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What is a sell-off?

A sell-off is when a significant amount of securities are sold within a brief period of time, and those security prices face a sharp decline. Sell-offs, also referred to as "panic selling," are typically the result of an event occurring that provokes a large group of investors to sell their shares out of panic. Sell-offs can occur with stocks, crypto, bonds, funds, and other types of assets. They can occur any time the market is open, even if the security is in a bullish market.

Sell-offs can occur as a result of poor earnings results, natural disasters, a report of inflation, rates rising, analyst downgrades, and other occurrences that are perceived as negative by investors. A sell-off is often short-lived and doesn't exist for extended periods of time. However, it can trigger a trend reversal and cause securities to enter a bearish market. Many of the top stocks in the world are experiencing a downtrend, but a sell-off can make the market prices drop even further.

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What are the signs of a sell-off?

Unexpected global economic events can point to a sell-off.

Usually, a person panics when something catches them off-guard or surprises them. When Sony announced that it temporarily stopped production of the Playstation 5 console in early January, it took investors and consumers by surprise and share prices fell shortly after.

In March, during its earnings recap for the fourth quarter of 2021, Rivian reduced its expectations for the number of trucks it plans to produce for 2022. The company plans to produce fewer trucks than expected and the prices of Rivian shares fell shortly after.

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Institutional investors or “whales” selling a large number of shares can cause a sell-off.

Institutional investors and “whales,” which are investors who have enough capital to shift the price of a stock or cryptocurrency, can cause a sell-off. This can also occur with penny stocks and meme stocks that are heavily volatile anyway. If retail investors see that an institutional investor or a well-known public figure sells their investments in a company, those investors could rush to sell their shares as well.

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Jeff Bezos sold nearly $2 billion worth of Amazon shares in May 2021, which caused the share prices to drop. There were also sharp declines multiple days later. One of the reasons Bezos was selling the shares was to help fund his aerospace company, Blue Origin. Even though he didn’t even sell his shares for a bad reason, it still contributed to panic selling.

Whales are much more powerful in the cryptocurrency market. You can often find retail investors following what they're doing. One of the latest examples is the Terra stablecoin. Terra was known to be one of the most traded stablecoins and was pegged to the dollar. Now the coin is only worth approximately six cents, and it's essentially worthless.

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One of the beginning stages of Terra’s demise was when a whale sold a significant amount of UST on May 7. That sale would cause a snowball effect, where casual investors and even those who staked their UST sold their shares as well. This is one instance where a sell-off continued and caused a complete market crash.

Technical indicators show an overbought market.

Technical indicators should be relied on independently, and should be used in confluence with fundamental analysis. However, they can help indicate when a sell-off is about to occur. The RSI (Relative Strength Index) indicator is one of the most common tools used to view momentum, as well as overbought and oversold market conditions.

When the indicator has a value between 30 and 70, that means the market for that security is normal. When it’s above 70, the market is overbought, while it's oversold when below 30. When the RSI reads that the security is overbought, it could mean that a sell-off will occur soon.

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