Sticking to broad-based stock ETFs and using stop orders can control portfolio risks, says analyst.
Despite a down day in U.S. stock markets on Tuesday, there were some very good technical signals that should give investors optimism going forward.
The first indicator was that markets held a majority of Monday's historic gains. For example, the Dow only gave back 8% of the prior day's gains. The NASDAQ was a bit weaker, giving back about a third of Monday's gains.
That means major broad stock indexes' cups remain more than half full. And remember, bond traders had Monday off due to the Columbus Day holiday. That meant we really didn't have any idea how credit markets would react to a globally coordinated effort to pump liquidity into credit markets by the U.S. and European governments over the past weekend.
So stock traders got their first chance to weigh in on the latest credit-easing measures on Tuesday. The fact that stocks didn't sell off implies bond traders had become a shade less pessimistic. After all, if credit concerns had remained elevated, stocks would've sold off much harder.
We actually moved client portfolios from all cash to about 30% equities on Friday. That was as the market was rallying late in the day. The S&P 500 dropped to 853, or 6.2%, early in the morning. Later, it fell to 842. The index wound up moving up to close at 899. Although it finished down 1.1% on the day, 15 minutes before the close, the index was actually up 2.8%.
More importantly, an hour before the close, the S&P 500 was down 7.4%. In the last 45 minutes, the benchmark jumped 11%. That's the rally we bought into in anticipation of Monday's 11.9% rally.
Capitulation Day
If you remember the last Technician column, on Oct. 9 (actually written a day before), we were looking for a capitulation day to take place soon. (See story here.)
In other words, indications were strong that the market would wash out enough sellers to make room for new buyers to enter. And that happened on Friday, making way for Monday's strong action.
As a result, even though markets were slightly down on Tuesday, it was victory for investors. We saw Monday's gains hold for the most part—setting up the potential for more of a rally going forward.
We've adjusted our price target on the S&P 500 to 1150, representing a potential of 15% more upside from today's close.
At the same time, we put a stop-loss on each of our purchases. Originally, those were set at Friday's low-points on the S&P 500. But we've adjusted to set those stop-losses to Monday's low. That's how we manage the risk in this volatile environment—we hope for the best while preparing for the worst.
Although we still feel like there's a good chance for more gains, we won't let our positions fall past Monday's lows.
We're staying very broad right now. We've added the SPDRs (AMEX: SPY) at $90.90 per share on Friday. Initially, our stop would've been at $83.48. That was the low-point of the day minus a dime and represented an 8.2% margin. Now, we've moved the stop up to $89.85, which is a dime below Monday's low point.
We also bought a bit of Diamonds (AMEX: DIA) for $86.40 per share. We set the initial stop at $78.84, a dime below that day's low. That represented an 8.7% downside risk. We've moved that stop up to $87.36, a dime below Monday's low. That should lock in a profit of at least 1.1%, thanks to Monday's huge move.
We bought three more exchange-traded funds as well on Friday: PowerShares QQQ (Nasdaq: QQQQ), MidCap SPDRS (AMEX: MDY) and iShares Russell 2000 Index (NYSEArca: IWM). The same strategy was applied with setting tight stops on each.
No V-Shaped Rally
On Wednesday, it would be nice from a technical standpoint to avoid seeing Tuesday's lows taken out. This probably isn't looking like a V-shaped rally. We're hopeful the market is setting up for a more extended run that could take weeks or even months to work through.
If we see a breach on the S&P 500 of 912.75—Monday's low—that would be extremely disappointing. We'll start moving back into cash at that point.
But while we see a breach of Tuesday's low (972.20) as discouraging, it would probably be too early to bail out completely at that point. The difference between those two points—972.20 vs. 912.75—can be considered a no-man's land of sorts in this market.
But you've got to draw a line in the sand. That appears to be 972.20 at this point.
This isn't about being a brilliant strategist. In markets like these, discipline and protection of capital has to be first and foremost.
Jerry Slusiewicz, president of Pacific Financial Planners in Newport Beach, Calif., is a regular contributor to IndexUniverse.com. He can be reached at:
