The early April 2025 market selloff was not a "healthy correction"

Even if you don't follow the stock market closely, you probably saw headlines about how the major indexes (Dow Jones, S&P 500, and Nasdaq) suffered significant declines on April 3 and 4, 2025, the two trading days after Trump's tariff announcement. In this post, I argue that far from being a "healthy correction", the declines we saw in major US stock indexes from the afternoon of April 2 through the close on April 4 are actually very unusual and possibly a troubling sign of what's to come. Therefore, in my unprofessional opinion, investors should exercise extreme caution before buying significantly into US stocks in the near future. Although I have my own political biases (anti-Trump) that certainly color my analysis (as does everyone), I will try to keep this post as focused on objective data as possible.

The Lead-Up

As near as I can tell, the actual "announcement" of Liberation Day tariffs took place the morning of March 21, a couple hours after market open (as can be seen in this video). This gave market participants plenty of time to position for the tariffs, which Trump had campaigned on, and which he promised to finally enact.

Liberation Day and Market Reaction

The big day finally arrived, and the press conference started. In this chart, the blue background area shows the time when the market was already closed, which is when the press conference started.

As you can see, on the afternoon of April 2, some initial optimism soon gave way to a massive and sharp drop in S&P 500 futures. We'll revisit this later. For now, let's look at what happened over the next two trading days.

There's no way to describe this price action as anything but two straight days of relentless selling.

The Spin

Naturally, those who support Trump and his tariff policies downplayed the market reaction.

And the Boglehead/buy and hold/"DCA and chill" crowd was also predictably unbothered.

I argue that any reaction that focuses on the relatively modest price drop, such at the ones outlined above, is downplaying just how bad, and unusual, this selloff was.

What Actually Went Down

Historical Significance

Unusual Whales is a subscription service that sells data for retail traders. And as with many such platforms, their social media accounts are prone to clickbait. However, in this case, they're completely accurate. This was a historically bad two day period for the S&P 500. Friday the 4th was also the largest trading volume day, notionally, in history for the S&P 500.

(source: barchart.com)

Often, high volume days occur at the beginning of a longer trend, which in this case is not a good sign for bulls. Friday, in particular, was anything but a "pullback". It was unmitigated panic selling. Trading entities were aggressively dumping US equity holdings hand over fist, eager to be out of these positions before the weekend.

The Specifics of the Tariffs Were the Trigger

Everyone who does short term trading knows that in the age of high frequency trading, the "algorithms" react to news instantly, whether that's financial data, earnings reports, or Fed speeches. This was no exception. Recall the chart of S&P 500 futures from April 2nd that I included above. If you're curious what happened just before that huge drop, I can tell you precisely. It was when this now infamous "reciprical tariff" board made an appearance at the press conference.

I use quotes because, as is widely known by now, the tariff rates that are supposedly imposed by each of these countries is flat out wrong. The numbers are based on trade imbalances, rather than tariffs, which is a completely different concept. Others have already explained why this is wrong, thoroughly and repeatedly, so I won't rehash it much here.

As is often the case, Derek Thompson puts it well.

One of the highest tariff rates, 50 percent, was imposed on the African nation of Lesotho, whose average citizen earns less than $5 a day. Why? Because the administration’s formula for supposedly “reciprocal” tariff rates apparently has nothing to do with tariffs. The Trump team seems to have calculated each penalty by dividing the U.S. trade deficit with a given country by how much the U.S. imports from it and then doing a rough adjustment. Because Lesotho’s citizens are too poor to afford most U.S. exports, while the U.S. imports $237 million in diamonds and other goods from the small landlocked nation, we have reserved close to our highest-possible tariff rate for one of the world’s poorest countries. The notion that taxing Lesotho gemstones is necessary for the U.S. to add steel jobs in Ohio is so absurd that I briefly lost consciousness in the middle of writing this sentence.

My point here is that the absurdity of this recipricoal tariff calculation is what spooked the markets and caused futures to rapidly plummet. If you don't believe me, you can double check the ES chart data yourself against this video of the press conference.

Volatility Spike

The other thing that happened on Thursday and Friday was the VIX mini-explosion.

VIX, a.k.a. the Volatility Index, a.k.a. (informally) the Fear Index, is a measure of how much volatility is expected in the S&P 500 over the next month or so. And while it can increase rapidly, as it did in this case (more than 100% in two days), that usually happens in response to exogenic, unanticipated events. For instance, the COVID-19 pandemic and subsequent shutdown saw a massive increase.

And it also spiked during the Russian invasion of Ukraine in Februrary 2022, although even then, not as much on a percentage basis as in April 2025.

The key thing to understand is that while the VIX can increase suddenly and unexpectedly, it always eventually goes back down as things calm. And sophisticated traders can make a fortune by exploiting that fact, especially during periods of high volatility (which, arguably, we were already in during recent weeks).

Hedge Funds, Margin, Leverage, and Forced Liquidations

Let's talk about the market participants that lost a ton of money on April 3 and 4th. Although many of our retirement accounts took a "modest" hit of 10-12%, some traders and hedge funds lost far more than that.

We don't have time for a full discussion of stock options here, and the topic is too broad anyway. But for our purposes, suffice it to say that:

• Option trading is a significant driver behind price movements in the major US stock indexes.
• Retail traders and institutions alike are trading historically high volumes of options.
• Selling out-of-the money put options is generally very profitable. However, when things go wrong, it can lead to large losses.

Because selling puts, or "selling volatility", is generally quite profitable (since doing so can make profit even if stocks stay relatively flat), a lot of heavily capitalized traders and hedge funds do so systematically, and with leverage. Meaning, they are borrowing money from banks in order to take on the risk of being "short volatility" (i.e. having sold puts). For those interested in the nitty gritty details, this post provides a nice outline.

But as I said above, this can go very wrong when the price moves against you. To give a real, but even understated example, a put option that a trader sold for for, say, $1000, might cost her $10,000 to close, for a loss of 900%, if the market drops significantly and unexpectedly. Now, of course, the buyer of that put option just made a killing, but that's a different discussion.

When those large losses start to pile up, even the big players are suddenly at risk. Their banks (which technically hold the positions on their books, on behalf of those clients), issue a margin call in order to limit their own risk. After all, Citadel and JP Morgan aren't about to let themselves lose money just because their clients took on too much risk (if they can help it). This means that the traders must deposit additional cash to cover that risk, or sell some of their other positions (i.e. shares of stock) for cash. On April 3-4, this was happening a lot. The traders being forced to liquidate undoubtedly suffered heavy losses, and many funds likely went bankrupt over the course of those two days.

My point in telling you this isn't to generate sympathy for those funds. The actual people involved will undoubtedly be fine, anyway. My point here is that these entities are highly sophisticated market participants, which employ analysts and traders earning 7-8 figures per year. They have the best technology and data that money can buy. They siphon off some of the brightest minds in the world to help their clients earn as much money as possible (or at a minimum, lose less than the overall market, hence the term "hedge"). And last week, they were caught on the wrong side of their trades so badly that many were wiped out. This is not normal.

Conclusion

I hope I've done a convincing job of explaining why the selloff in US stocks over the last few trading days was far worse than a "healthy correction". Unless there is swift reversal on the tariff policies that were outlined (which doesn't seem likely, as of this writing), I fear it is actually a troubling sign that there is more downside to come. And given that the market is forward looking, this also doesn't bode well for the near-term financial wellbeing of Americans.