The move lower again today once more caught a lot of investors off guard as it seemed at the open as if the market direction was going to push higher. In fact a lot of investors have been caught in this last rally from Friday and Monday as they felt it had the potential to recover the lost momentum and push back towards the new highs. If you were among those who were trading with the belief the market direction was strong enough to move higher you should not be disappointed in your error.
To understand better though, it is worth looking back at the 6 month daily S&P 500 market direction chart to see the pattern that has developed and determine what the technical outlook is now advising investors.
S&P 500 6 Month Daily Chart
The 6 month daily chart below of the S&P 500 gives a clear picture to those investors who like to follow a market direction technically. I have marked the key aspects on the chart below. Let’s review them:
A. The market last fall put in a triple top which many analysts called a head and shoulders pattern and declared the market direction rally up as now over. They were wrong of course and the market direction pulled back to point E in the middle of November which saw the market direction fall through the 50 day, 100 day and 200 day exponential moving averages (EMA) and then commenced a rally which pushed the S&P 500 up 316 points for a 23% gain. A big part of the rally was the belief that bonds were “dead” and the best place to be was in stocks, particularly dividend stocks and so investors both the pros and the retail bought up dividend paying stocks.
B. The first test of the rally of 2013 saw the market fall back to the 50 day moving average (exponential moving average (EMA)). You can see that once the 50 day was tested at point F the market direction continued higher.
C. The second test of the rally came in April and once again the market direction pulled back to the 50 day EMA and then pushed higher.
D. This latest pullback is different as you can see from the chart. We have had three tops, each one lower than the previous higher. The market tested the 50 day EMA last week, bounced off it and has today returned back to the 50 day EMA. Note how different this top looks. It is much closer to the top of point A back in the fall of 2012. This could then be setting up the market direction for a more serious correction that may eventually end up looking like last fall with the market direction correcting all the way down to the 200 day EMA.
Once you look at a chart such as the 6 month chart above you begin to get a different picture of the recent market direction. You can now see that perhaps it would be best to take some action to profit from a further probably downturn in stocks.
For FullyInformed members I wrote a strategy document in October 2012 which details out how I approach a correction. Members can review that article here. A second strategy article I wrote on Feb 9 2013 was called 8 Simple Strategies To Profit From Bear Markets and Corrections. Members can review that article here. There are a variety of other articles which look at strategies and ideas for profiting from corrections. For FullyInformed Members, select this link to review the available articles. For non-members select this strategy to review a variety of articles.
Protect and Profit From Ongoing Corrections
When the market direction up corrects investors should learn to benefit from the increased volatility that corrections bring. Even doing simple strategies like selling deeper in the money covered calls or even at the money covered calls on stocks or ETFs that are under pressure helps. Corrections are a perfect opportunity for long-term stock and ETF holders to profit through selling covered calls and rolling them lower as stocks move lower. Then as the correction stalls, buy back the covered calls to lock in profits and wait to see if the correction will continue or the market direction rally back.
There are also all kind of Ultra Short ETFs like SDS and DXD which can be bought and held for even a few days to earn very good returns. Other options are such funds as HDGE, the AdvisorShares Ranger Equity Bear ETF. Personally I am not a big believer in these types of ETFs. I prefer SDS or DXD simply because they are based on the overall market, whether it is the Dow or the S&P 500. For example today the HDGE fund was up just 0.18% while the SDS was up 1.66% and the DXD was up 1.59%. Overall I think anyone can handle a downturn in stocks and profit from them through the Ultra Short funds rather than ETFs like HDGE but everyone has their favorite method.
No matter what method investors choose, the most important aspect of a correction is to learn to profit from it and watch for the signs that warn the correction will continue. When you look at the 6 month chart above and the past corrections, you can see the pattern of this correction and how it differs from the other corrections this year. I will not be surprised to see the market fall to the 200 day EMA and then stall there before deciding whether it will move lower or turn back up.
Driving Factor for Market Direction Rise
One last thing to mention is that no matter what analysts tell you, in the end there has to be a driving factor that pushes market direction higher and keeps it moving higher. The most powerful market direction mover is always revenue. If revenue can grow in the next quarter, look for stocks to rebound. If however revenue disappoints stock may move lower into the summer months.
My market timing technical indicators are such that they look only a few days out. Anything more than that is a guess by even the very best market timers or analysts. No one knows what weeks ahead holds for stocks as there are many factors that influence stocks, markets and the economy which cannot be predicted with any reliability. This is why I always stay with short-term indicators and use my correction strategies as outlined in the links above.
What is important as investors though is to realize that downturns, like upturns, are profit-making opportunities and through even simple strategies, investors can learn to profit from corrections as much as they can from rallies.
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