Deprogramming the Cult of the Retest

With stocks' big rebound, analysts predictably wonder if a retesting of old lows is inevitable. But as is always the case when market expectations are running high, the notion of a certain retest is worth treating skeptically.

A retest is a psychological event. After a sharp jog lower, stocks have inevitably bounced back, perhaps because short-sellers are buying back the shares they borrowed, or because traders are out to make a quick buck, or perhaps because dip-buyers are adding to positions on blind faith. But sometimes the buying is more substantial than that. Sometimes there are honest-to-goodness investors who are behind the bounce -- people who believe valuations have come down to a point where buying stocks and holding on to them is reasonable.

Over time, theoretically, the shorts cover, the traders take profits, the dip-buyers cave and stocks fall anew. But if actual investors were involved in the bounce, they will buy again as stocks approach the old nadir. If the buyers have adequate firepower, stocks will rise again and stocks will, in the parlance of technical analysis, have passed the retest. If investors lack the reserves, or if they weren't buying to begin with, or if their past confidence falters, the market will fall past the old lows and keep dropping. The retest will have failed. ...