S&P 500 Continues to Violate Key Support Levels; Gold a buy?

Thursday March 5, 2009, 11:46 am (SPY @ 69.12).   

Since last post, 11/21/08 (S&P 500 Violates Key Support on Heavy Volume)

Thu 11/20/08 (SPY @ 75.45) I 

I warned about "catching a falling knife," stating the SPY had 

 plunged through the ice after bouncing off it 3 times.  It was a decisive, high volume penetration and the nearest support would take us back to the lows of 2002-3. 

As it turns out, the SPY rallied back above those lows for a time, generated a false, brief buy signal with no follow-through, and the falling knife has now fallen to the lows of 1996!   A snapback rally or two cannot be ruled out, but this ia very sick market with little nearterm support.  

To update, if you were using a trailing 20 day buy stop to reenter the market and a 20 day sell stop to exit it, you would have been SHORT THE SPY SINCE 125 with only 1 false buy signal on the way down!! That's a 65 point open profit! The current buy stop if you are using this system is 87.74 but will probably drop soon. 

Gold (GLD @ 90.05) is also looking very interesting.  Fundamentally, the case for gold could not be stronger with central banks around the world racing to print money, in effect diluting their currencies (in which their debts, conveniently enough) are denominated.  This is reminiscent of the late 60's, early 70's, when the Great Society Program, Vietnam War, and Apollo moon shot all conspired to swamp the federal budget.  Curiously, inflation and interest rates remain tame this cycle, apparently because future economic demand is so massively discounted.  

One of the silliest arguments against market timing is that you have to make 2 decisions - when to sell and when to buy back - and get both right.  Although I am an advocate of buying and holding and dollar cost averaging with the bulk of your longterm assets into a sensibly diversified portfolio, there are a few moments in time when side-stepping or lightening up during a major decline can really improve your long term returns.  This is probably one of those times.   

If you still need to lighten up to sell down to your sleeping point but are afraid of missing the next upsurge (and it will come, whether in 6 weeks or 6 years is anyone's guess), use the simplest of all technical signals to re-enter the market.  If you can't trust yourself to do it, immediately enter a buy stop order at the time you sell.  For example, let's say you owned 1,000 shares of SPY currently at 69 and change.   If you wanted to sell, go ahead and do so, then turn around (once filled!) and place a buy stop order at 87.75 (a bit above the 87.74 4 week trailing high).  You have to adjust the dollar amount for the higher price (assuming you want to keep the same dollar amount long stocks when the market turns, so would divide you $69,000 proceeds by 87.75 to come up with 786 shares (rounding down).  So your order would read: 

  Buy 768 shares of SPY stop at a stop price of 87.75 good til canceled. 

Done.  Now you can go on vacation, to your day job, golfing, whatever, and if the market really surges on you, you won't miss out on all the upside.   

What is the good of buying at such a high level relative to today's market? you might ask.  Several.  First, if the S&P 500 reaches this level, it has significance, because at that point many traders and market participants are showing a profit.  Those who were waiting until they had an opportunity to sell at around 87.74 have done so, eliminating or reducing immediate overhead supply.   The headlines of newspapers will no doubt trumpet the fact that the marked is marching higher, and Joe Public will call his broker and start to move some money in, driving the market higher, etc.    

Now 87.74 is 27% higher than the current SPY value of 69, but it is very unlikely you will be filled at that price.  

Why?  Because as time progresses, if the market continues to decline or move sideways, the trailing 20 day high will also decline.   You don't even have to count bars or calculate anything.  Simply follow this link and read the rightmost value of the "CHAN(20)" indicator.   That's it.   

If nothing much changes, the indicator should be at 80 in a couple weeks.  At that time (or earlier, as dictated), you would modify your open buy stop order to reflect this new reality, changing the buy price from 87.74 to 80.01, let's say.   Since you are buying the shares at a lower price, you can increase the number to keep the dollar value constant:

  $69,000 / 80.01 = 862.39. 

Round off and you must now modify your order to read:

  Buy stop 862 shares of SPY at 80.01 stop GTC.

I don't know about you, but this gives me a very satisfying feeling for several reasons:

1.  I am guaranteeing that the market will not run too badly away from me, making me regret having sold at the bottom.
   
2. I have now increased the number of shares I will purchase if filled from 768 to 862, a 12% greater position in share terms.  If the market eventually recovers to higher ground, all things being equal, my profit will be 12% greater from this point on. 
3. I am still sitting safely in cash, but am not at risk of second-guessing myself when or if the market turns.  I don't have to lie to myself that I will wait for a pullback when the inevitable occurs, because the market order will be executed automatically. 
4. I collect interest (not much, but it's something) on the money invested in a money market mutual fund.
5. I have the satisfaction of knowing that any future declines that do not trigger my buy stop will eventually lead to my buy stop being lowered, which in turn will mean I will enter at a much better price.   The market's decline is now turned to my advantage - rather than lamenting the daily lurches of the market downwards, I can even get a certain tactical and strategic satisfaction.

The best way to convince yourself is to do this.   What you must be prepared for is the inevitable false breakout (buying, then getting stopped out a few days or weeks later) as well as the regret of having to turn around and buy at a higher prices shares you sold at a lower price.   Most people cannot handle not being perfect, which is why I believe automating your system as much as possible is critical.   I tell myself that the difference in the buy price and liquidation price assuming the buy price is higher is the cost of insurance.  Avoiding one sickening market decline as occurred in 2008 and now and in 2001 or 1973-4 will make up for decades of getting nickled and dimed by being stopped into and out of the market. 

If you want to minimize your frustration even more, assuming you can be honest with yourself and follow through, you could modify the system as follows:   once a breakout occurs above the 20 day high, wait for a pullback.  There are several options including 3 lower highs in a row (put a buy stop above the high of the prior day) a pull back to the middle of the 20 day channel (halfway between the 20 day high and 20 day low) which you could do with a buy limit order at this price or using a moving average, such as the 50 day, assuming the price is above the 50 day when you buy.   These are all variations on a theme - I personally use combinations of these including Williams %R, but you have to find what suits you.   A combination of limit and stop orders, though, with a sensible, simple system that you have thought out ahead of time, will improve your sleep and your returns while allowing you to keep a day job and have a real life.  

And that, after all, should be the objective. 

The legendary Turtle Traders use a modified version of the above break-out system.  They also have a modification that if the last signal (whether taken or not) would have led to a loss, DOUBLE the amount on the next system.  You would be surprised how often this works.   False signals are often followed by true ones, and false signals are some of the most useful in technical analysis.