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Markets and Stop Considerations

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Last week was quite a week in markets. It was the biggest weekly drop in the S&P 500 in two years. Now the old saw “sell in May and go away” seems like wisdom in that markets are below their May-end level.

Markets

This graph of the SPY shows the damage done last week related to the progression of this major move upward:

spychannel

As shown above, SPY has broken through its 50 moving average and seems headed for its 200 day moving average which is at the bottom of the channel that SPY has been in since late 2012.

John Hussman, one of the better economic and financial analysts offered this commentary:

We’ve come to avoid pointed warnings in this market, because speculative conditions have extended much longer than in other cycles. Indeed, we’ve had a few deteriorations in recent years that reversed fairly quickly as investors shifted back to risk-seeking, particularly after fresh initiatives or assurances about monetary easing (though further initiatives may not be forthcoming in this instance). So we’re open to a favorable shift on these measures, and if that was to occur following a somewhat greater retreat in valuations, it could even open up some amount of constructive opportunity. Meanwhile, despite our view of stocks as severely overvalued, our response is to remain defensive without taking a stance that greatly relies on immediate market weakness.

The paragraph above is consistent with my views.

No one knows whether this is a major market correction or whether it is just another penetration of the 50-day moving average. There have been seven penetrations since January 2013. “Buy the dip” worked all the way up as the market rose more than 40% during this period. At some point that strategy must fail, if only because financial asset valuations greatly outpaced economic conditions.

My guess is we are either at that point or very near it. But it is only a guess and I thought that on previous dips.

Stops

If you are going to participate in these markets and can do it at a reduced involvement, that would seem prudent. This may be just another dip or it may be the beginning of another harrowing market adjustment. If you are in markets no matter the extent, stops are suggested. The table below shows the selections for August and the ATRs (average true ranges) for twenty periods on a daily and weekly basis. These reflect the volatility of the ETFs (convert them to percentages of the current price should you want to compare ETFs of different values). Depending upon your risk aversion, you will set a stop at either a low or high multiple of the ATR.

stops

These are not normal markets. Do not assume they are. They may continue to levitate for a while, possibly even a higher level. The nature of the economy and the bind the Federal Reserve has gotten itself into suggests the probabilities are toward the downside and possibly dramatically. Make sure your position(s) are protected on the downside. Better to be whipsawed with small losses than to get caught unprotected in a violent move down.

Good luck and good trading.

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