There were, in fact, five stages of selling during the severe pullback in oil and energy-related stocks. Here's a timeline of how it happened.
1. The Facts Come to Light (2 Months Ago)
Signs emerge that energy prices are too high. There is oversupply, coupled with lower demand. None of the major producers (Saudi Arabia and other OPEC nations; plus Russia, Brazil, Nigeria and the U.S.) seem to consider cutting production. The U.S. dollar strengthens, putting downward pressure on prices.
The PowerShares DB US Dollar Index Bullish(UUP) - Get Report , which reflects relative performance of the U.S. dollar vs. a basket of other major currencies (including the euro, yen and Swiss franc), responded strongly.
2. Initial Fear (4 Weeks Ago)
Investors start to worry that prices won't find a bottom for another $10, $20, $30 or even $50 per barrel.
What if oil, natural gas, propane and gasoline lose all price stability? Investors decide to sell now before everyone else discovers this. This selling sends prices even lower, which fuels more fear.
3. "Justified" Selling (2-3 Weeks Ago)
After the first round of selling, the apparent smart money comes in and determines that things are looking bad. Market commentators say that because of how much exposure the high-yield bond market has to energy, a spike in both yields and defaults is inevitable.
And now that the Fed is going to be raising rates, the thinking went. Then a domino effect would soon follow, punishing those who reached for yield.
With depressed oil prices and a frozen high-yield debt market, newer U.S. shale producers would be forced to shut their doors before they even put their names on them, panicking investors feared. OPEC has most recently agreed to maintain production at current levels (which created the oversupply) and says it won't consider a cut for six months.
This caused absolute carnage. Investors decided to get out.
Stop limits are triggered and stocks of profitable companies are sold 10% to 15% below where they traded a month prior. Nobody is buying energy shares.
4. Tax-Loss Selling (A Week Ago)
At this point, we are past the initial wave of selling and investors are in no-man's land.
At these prices, it's not really compelling to buy or sell. It feels like there may be some further downside, but selling now is slamming on the brakes while hydroplaning. Everyone knows you're supposed to calmly ride it out.
But is that really possible?
This is when we heard pundits and major financial institutions' chief investment officers discussing on television how energy would be a great opportunity at some point in the future. Not today, of course, but at some point in the future.
Right now it's a falling knife.
5. Margin Calls and Forced Liquidations (Monday)
These are not transactions anyone wants to be making on the sell side. Accounts and funds that employ leverage to bolster returns must maintain a certain level of equity in their accounts. When that level is breached it's time to raise cash.
What gets sold in these instances is not necessarily what the account holder wants to sell, nor is it typically the time (or price) at which they want to sell it.
Here's an illustration of the moves in Brent crude oil, the JPMorgan Alerian MLP Index(AMJ) - Get Report , the Energy Select Sector SPDR(XLE) - Get Report , and the SPDR S&P Oil & Gas Exploration & Production Index(XOP) - Get Report through Monday's close.
And then the bottom is in.
Here are the same positions through Thursday's close.
That's how Tuesday and Wednesday felt, anyway. Because of yield support and some stabilization in the price of oil, it feels like we have reached and surpassed the point of maximum pessimism in energy. And in very short order.
Could things get worse from here? Sure. Anything could happen and there is no shortage of catalysts for further geopolitical fireworks. But if you believe we just lived through Margin Call Monday, it may be a better time to buy than sell.
About $60 right now.
This article is commentary by an independent contributor. At the time of publication, the author's firm held positions in AMJ, UUP and XLE.