Market is currently oversold and the H+S pattern is still in tact. Great time to get short.
Observe.
This is what the market did.
The market is testing the new trendline created from the head and shoulders pattern as seen below.
A similar pattern is shown in the S&P
It’s very rare for a head and shoulders to fail, but possible.
Additionally note the fractal pattern potentially from here we could form an even bigger head and shoulders pattern with a fractal breakdown as this has been mentioned earlier.
Note that even if we break through to the upside and this head and shoulders pattern fails, as we saw in 2000 the top can be tested several times. Still, it’s possible we test the lows only to rally and breakthrough the downtrend line after a long term retest of this longer head and shoulders.
I look at today as a wonderful opportunity to move to cash and get short in some names.
I know, the rally was the “smack you in the face, as if the bulls have escaped from prison type of rally”. In spite of the fact that we surpassed the original breakdown levels, the tendency and trend is still in tact, indicating we will continue to trade lower. That means that this rally should be looked at as an opportunity to get short.
On the other hand, there are some cheap stocks out there worth buying, in spite of the rally, and the potential for the decline as well, provided you have a long enough perspective.
If you are a Buffettologist, you need consumer monopolies. Products that stand on their own for the long term with the brand recognition so that no one can touch them. Hersheys and coke are such examples, but there are many others.
Hints for a company that is worth getting, is that the company has high ROE, high margins, and high turnover. ROE above 10% is suggested, while an “either or” type of thing for margins and turnover is needed.
I would use this time to identify the types of companies you want to own, and then decide at what price you are willing to pay.
In the meantime, if you already own some long term plays, you may want to use such strong evidence of a downtrend to add some hedges via inverse etfs and/or lighten up on them if they are up significantly.
Soverign wealth funds are collapsing, major governments are looking for ways to survive, but they are all at high risk. Meanwhile, option ARMS resets are starting to hit the market violently and may result in an unwinding ofthe mega 700 trillion derivative bubble.
My guess is eventually the status quo will return and the money will be pumped back in, but in the meantime, unemployment remains very high, and the resulting high gas prices and high food costs that will be associated with continuing of the policy to lower interest rates means fewer and fewer consumers will be able to support those high prices, with or without a job, and meanwhile, businesses will hurt from high costs of energy. Meanwhile, the BP spill should result in similar problems and should only inflate these problems, and that means that any move the fed makes isn’t really going to help in the short and medium term.
On the other hand, out of neccesity, eventually things will most likely return. People will continue to buy items like coke around the world, lightbulbs and household products sold by GE and P&G, and that means, that the short term and medium term worry will only offer better deals for those looking to accumulate and hold stocks for the very long term.
I believe it’s smart to have a bit of a hedge so that if things get worse, you not only have the cash to buy lower, but also the hedge in which to sell to raise cash to buy lower.
Even if this is less than 10% of your portfolio, it will help. The way to use it is that if stocks decay and this reduces your overall position size of long stocks and your hedge, your hedge may go from a 5% stake and become a 10% stake, So you can then sell half, take profits, raise cash, and use some of this cash to buy stocks lower. If stocks go higher, you can either reduce position size in some of those stocks, or you can add some to your hedge, or a combination of both.
There are additional risks associated with inverse ETFs, however, you won’t have to worry about a margin call this way, as an inverse etf can only go to zero. You can get long volitility futures via VXX or VXZ. This will give you a hedge as when stocks decline sharply, volitility goes up generally. Or you can own an inverse etf, or a 2x leveraged inverse etf or even a 3x leveraged inverse etf. The higher the leverage, the greater probability that the etf goes to zero, and the less useful it is as a long term hedge.
You could short individual stocks, or buy puts. Shorting stocks has the risk of the stock soaring higher, which can result in a margin call if you don’t have enough cash. You are then forced to sell stocks you may not want to in order to raise cash. But with puts you don’t have margin calls. However, the option can expire out of the money and that means you lose 100%. The probability of you losing everything is much greater with options, so it’s wise to keep a lot more cash available if you use options, especially if you use out of the money options who’s cost is much lower, but probability of going to 0 is much higher.
If you have any profits from the recent rally (after fees+expenses), it may be intelligent to take at least some profits so that you have more cash to add shares at lower prices if you get the chance, while protecting your gains.
The way to play this trend is continuing to estimate we go lower, and to hedge accordingly until the downtrendline breks, or until we reach our target price. However, occasional rebalancing after large selloffs or large gains is suggested.
Ultimately, you should only play the mmarket in a way you are comfortable with. Don’t worry about hedging if you don’t want to. If you do want to hedge, don’t hedge the same day. Leave cash, scale into a position as the market and the individual stocks trade lower, and add hedges, or reduce position size of longs as we trade higher. This way you give yourself a chance to only take profits when positions are up, and only add to stocks or hedges when it is cheaper.
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