Sunday, September 6, 2015

Embrace the Bear

Welcome back Active Traders and Wealth Preservers.  In case you haven't been paying attention, we have a major bearish setup developing in the markets.

Most media outlets consider 10% to be a correction. By that measure and from their tops,  SPY is down -9.87%,  DIA is down -12.2% and QQQ is down -10.6%.  But that's just from the top, On a year to date basis, SPY is down 6%, DIA is down -12% and QQQ is down a mere -1.09%.  Not such a big deal, right?

Things get ominous however when you look at the weekly chart which shows a downside break of the ascending trend line formed off the lows set back in 2011.  And immediately after that (it's tough to see but trust me), prices spike lower, race back up to the trend line,  then fail and turns back around to the downside.  That's where we are right now. What I am expecting next?

I expect we are going to revisit the lows set last Monday 8/24 which is about 6% down from here on the SPY and that's just getting started.  After that, the next likely target is 173 on the SPY. Looking further out I think the eventual down side target for this move is going to be the 161% line which is about 155 on the SPY.  That is down a hefty 20% from these levels and could take several weeks to reach those levels.

So what can you do about it?

1) You can raise cash if you have not already.  I am about 50% in cash at this point.

2) Buy short ETF's to offset your longs.  This may be preferable to simply selling your longs since that may trigger paying a long term capital gains tax on positions you may have been in for several years.

Use this table to find matching short exposure ETF's to offset your longs.  Note that you may have to buy a multiple of shares of the underlying to offset your exposure.  For example, if you are long 100 shares of DIA, you will need to buy 430 shares of DOG to effectively offset your long stock.

Now if you are long a bunch of ETFs (and I am long nearly every issue in this table) you may not want to put on 10 offsetting positions to offset the 10 you are long already.  You might just want to put on 1 or 2 large positions to offset your entire long side exposure. This way you can get out with just 1 or 2 trades instead of 10-12.

Another benefit of the short ETF's is that when things get really ugly, you can just close out the short ETF's and take a profit which is much easier to do psychologically then to have to enter new longs.

3) Put on some offsetting options positions.

Dan Nathan from CNBC's Options Action recommended the SBUX October Monthly 47.5/52.5 put spread for a debit of 1.0.  That trade as a max gain of 4.0 for a max loss of 1.0.  I like those and options positions with a similar risk/reward scenario.

4) Hold your nose and buy.

This would be an option for you buy and hold types.  Put in a limit order to buy SPY at 182.6 then 172.5 and finally 155.15.  This way you will scale in on the way down.  This strategy has the highest chance of success in the long term, but you will experience some pain on the downside.

Good luck in the weeks ahead.