Back on October 17th, we found reasons for an immediate bottom (which turned out to be an accurate assessment). And on October 19th, we identified some levels in common indexes that would allow us to hold long positions. Those levels have been recaptured. Now what? Our head is on a swivel, identifying if/then scenarios in an incremental risk environment. There is still overhead resistance at downward trend lines off the highs from September. We’d like to see new highs made, and kept. Anything below the levels identified on the 19th, and we are out of our long positions. Yes, tomorrow is FOMC day. Don’t trade what you think the market should do. FOMC days are notoriously counter intuitive (what ever the market does tomorrow, be ready for the opposite to take place in the following days). Trade what you see. Price holds the final say.
Investing is all about risk management. Preventing loss is just as important as realizing gain. There are periods in the market where Return of Capital is the more appropriate approach than Return on Capital. Now is one of those times. Those retirement vehicles (401ks, IRAs, etc.) that have exposure to the US equity markets would be prudent to reduce that exposure at this time. You are an adult. You make your own decisions. You do not make investment decisions based on what you read here. You know the drill.
The last couple weeks have done some structural damage to the market. We identified the need to watch the S&P 500 closely back on October 8th. Those levels broke down and were a sign to look for lower prices. We got lower prices and even broke significant support at 1900 on the S&P (by the way, breaking significant support levels are a hallmark of a directionally shifting market – in this instance, from an up trending market to a down trending market). What did this breakdown mean? Something has changed. Specifically, the likelihood of lower prices ahead has increased. That means risk has increased. We don’t like to lose money if we don’t have to… So when the market tells us something has changed, we listen. You should too.
After a good deal of studying many markets and charts, I’ve identified some levels on three US major markets (Dow, S&P 500, and Russell 2000) that would need to be recaptured in order for any equity exposure to be increased or reestablished. Right now, the risk of loss is too high to consider hanging around to see what happens. If these levels are not recaptured soon, then lower prices are likely. If these levels are not recaptured, the best case scenario is sideways price action for a few weeks. One thing is for sure, the next few weeks have a high likelihood of volatility (large price swings), which is also a hallmark of trend change.
In summary, the current potential for reward it too low compared to the current exposure to downside risk. The body of evidence (including Intermarket behavior, cycles, internal breadth, seasonality) point to a dangerous week ahead. We even noticed that today marks the 27th anniversary of the 1987 stock market crash. Does that mean it will again this week? Absolutely not. But volatility and risk are upon us. Buyers beware. Risk ahead!
Here are our levels as annotated on the charts. Hopefully, we can recapture these levels and evaluate the next move. Be careful, curious investor.
The Russell 2000 is an index containing – you guessed it – 2000 Small Cap stocks. It’s also an index that is breaking down sharply through resistance this week. The significance of this move is a higher probability of lower prices in the immediate future (over the next few weeks). Another impact is that most US markets are correlated to the Russell 2K. Capital preservation is a smart move. Cash is a position too.
The chart below may look complicated, but it’s actually very simple if we break it down. The index formed a double top with a negative momentum divergence (black lines). Support has now been broken (shaded area around 1100). The move from the highs through the shaded resistance marks equilibrium and our measured move to the downside (orange dashed lines). The measured move lines up great with a drawn parallel trend line (green dashed line) only touched back in October 2011. The aforementioned has also lined up well with a 50% Fibonacci retracement and the 200 week moving average. This confluence of resistance is a magnet and our downside target (a drop of 11%). The only other viable target I see is at the 38.2% retracement in confluence with the already established solid green trend line (drop of 6%). We’ll continue to evaluate this decline as it moves along.
How do we take advantage? Through an inverse ETF that goes up in value when the Russell 2K drops in value. A few choices:
- RWM (1x leverage): in general, every point move in RUT is a one point move in the opposite direction for this ETF
- TWM (2x leverage): in general, every point move in RUT is a two point move in the opposite direction for this ETF
- SRTY (3x leverage): in general, every point move in RUT is a three point move in the opposite direction for this ETF
All of the above carry risk to varying degrees. Our risk is defined: If RUT recaptures 1100, we’re out. Classic risk management. We have our stop. We have our target. Trade safe, curious investor.