Top 10 Myths of Tuesday's Correction

6. Stock prices will be higher six months from now.

This one is only half wrong: Based on prior one-day selloffs of 3% and 4%, what is most likely is that we will see higher and lower prices over the next six months to a year. So unless you plan on buying stock and then hiding on a desert island, prepare yourself for some big price moves.

Consider 1997: From Oct. 16 to Oct. 24, the market suffered three days where prices were down between 2.5% to 3%. The next trading day (Oct. 27), the Nasdaq dropped about 100 points (-6.2%). The day after saw a gap down of another 75 points, but then the market rallied, closing up over 9%! Some more upward progress was followed by an 11% setback. The washed-out markets set up a 30% rally by April 1998.

A similar pattern occurred in 1998. April 6 and 7 saw 1.7% and 2% drops, respectively, followed by oversold conditions, leading to a 10-day rally of about 7%. That set up some wild market swings over the next six months: a 10.7% selloff, an 18.2% rally, a 27.2% selloff. From there, we saw a near 20% snapback, leading to a 23.6% correction, and by Oct. 8, 1998, the markets had erased the gains for the entire year and then some. The deeply oversold conditions led to a rally that was up about 60% by the end of 1998, and tagged an 86.7% gain on by Feb. 1, 1999.

December 1999 and January 2000 saw several 3% down days. The market peaked on March 10, and two days later suffered a 6% (peak-to-trough intraday) whack. The next day was another hit of near 4%. These moves set 2000 up for what would turn out to be one of the wildest years in market history. From that March peak to the beginning of April, the Nasdaq dropped 29%. A 22% bounce by April 10 was followed by a 27% drop, a 23% gain and a 23% selloff. And that was all before May was over!

From the lows in May, the Nasdaq subsequently rallied 41% by mid-July. Between then and Sept. 1, the Nazz dropped 17.9% and rallied 21.0%. From September to December, the Nasdaq markets then dropped over 40%, to just about 2,300.

Here we are nearly seven years later, and we are less than 100 points above the levels of December 2000.

7. Selloffs such as this are healthy.

Moderate selloffs of 0.5% to 1% might be healthy, but the plunge this week was anything but.

What was unusual about the selloff this week were the volume and market internals. Volume on the NYSE and Nasdaq were record setting. The Nasdaq-100 Trust(QQQQ Quote) traded well over 300 million shares alone. Advance/decline ratios and up/down volumes were off the chart.

This looked like the kind of panic selling we see at the end of a long decline. Indeed, if we had been selling off for the prior six months, I would have been advising everyone and their mother to be in there buying hand-over-fist.

What makes this situation potentially dangerous is that this was the first day of the selloff, not the last.

The enormous distributive volume and the horrific market internals were anything but healthy. It suggests a major change in underlying metrics and psychology.