Volatility scare: Explaining Dow's wild ride

Wondering what the heck happened Wednesday when the Dow went into a death spiral -- plunging 565 points -- then reversed course in bungee-cord fashion to recoup more than half of its losses and finish down 249 points?

Here are some theories on why the Dow took investors on such a wild ride -- a trading session that kicked off a heated debate on Wall Street as to whether the intense selling pressure had reached a crescendo -- at least for the short term. (The Dow rebounded again Thursday, rising 116 points to 15,883.)

First, why such intense selling? Panic and fear is one reason. With headlines blaring 'Dow down by 500 points,' investors get nervous, especially after earlier news reports touting the worst start to a year for U.S. stocks in history. And when investors' fear levels rise, emotions take over, and people sell for fear of seeing all their cash in the stock market disapperaing overnight.

Another reason selling kicked into overdrive is that selling begets more selling. Big losses suffered anywhere in markets cause financial pain that then requires some distressed investors to sell other stuff to raise cash or prevent further losses. Case in point: there is talk that Middle East sovereign wealth funds, which have been decimated by plunging oil prices, were selling assets that they could sell -- such as very-liquid stocks.

And don't forget those computer-driven trading algorithms that generate selling without human intervention when key stock indexes fall below certain key levels.

Now, the fun part. What sparked the rebound, or what Wall Street says could have marked a key short-term reversal and the start of a counter-trend rally? Here are a few theories:

1. Short covering played a role. With the Dow down more than 500 points in a single day -- on top of a prior drop of more than 2,000 points since its May peak, investors that were betting against the market, pulled back on those bets, for fear of getting hurt if a rebound occurred, as it did. An investor that shorts the market borrows shares and sells them with the hope of buying them back at lower prices. So to avoid losing money if stocks shoot up, they close out their short positions.

2. Individual stocks went on sale. With the average stock in the Standard & Poor's 500 index down more than 25%, Wednesday's additional swoon meant many stocks got even cheaper, which brought in bargain hunters willing to make a bet on at least a short-term bottom forming.

3. Dow closes above August low. Wall Street chart-watchers eye key support levels closely. The Dow on Wednesday briefly breached its late-August closing low of 15,666 but was able to hold that level, which helped push blue-chip stocks higher into the close and finish at 15,767.

4. Small-caps finish up. The small-company Russell 2000, the only major U.S. stock market already in bear-market territory, or down more than 20% from its record closing high, actually outperformed the other three major stock indexes Wednesday, finishing up about 0.5%. That was a sign that investors were willing to take risk again and nibble at beaten-down shares.

A big turn higher in biotech stocks was also a catalyst for the reversal, says Mark Arbeter, president of Arbeter Investments.

Arbeter says the S&P 500's ability to finish above its October 2014 intraday low of 1821, after briefly tumbling below that key level, which occurred during the Ebola virus scare, was also a key development.

"Holding the October 2014 low was certainly a prescription for a rally," Arbeter told Paste BN