Jared Levy, Editor, Option Strategies Weekly
Friday, 19 August 2011
Economies around the globe are grinding to a halt. The eurozone is coming apart at the seams and the American consumer is losing confidence and strength. But just when you thought things couldn’t get any worse, a serious warning signal showed up in the S&P 500 and may have helped spark this sell-off.
A big storm is coming, and it’s going to be rough…
I’ll show you how to navigate the storm, identify and clarify this indicator, and help you make the decision to buy or sell.
Analyze This Death Cross!
Traders generally fall into one of two analytical disciplines: fundamental or technical. Either they research the fundamental aspects of a company to make their buy and sell decisions, or they examine the price charts of stocks to find support, resistance, formations and trends.
But even the most die-hard fundamentalists will use some sort of a moving average or basic indicator to confirm their ideas.
Two of the more common indicators that longer-term investors use are the 200- and 50-day moving averages. Basically, a moving average is the average price of the stock over a period of time. So a 200-day moving average tracks the average price of the stock over the past 200 days. Investors use these indicators to gauge a trend’s strength.
But they can also tell investors when to buy or sell.
For example, when the 50-day moving average crosses above the 200-day and the stock price is above both of them, this is considered a buy signal. As long as the 50-day stays above the 200-day average, investors will generally hold a position.
Sometimes moving averages signal big changes in trends.
The “Death Cross” or “Iron Cross” as some call it occurs when the 50-day average crosses below the 200 and the stock is below both averages. When this happens the bull market has ended and it’s time to sell. Sometimes this selling gets violent.
On Wednesday, after the close, a Death Cross was formed in the S&P 500 (SPX). When we combine this formation with inflation pressures and unemployment claims, we have a perfect storm for a mini-crash.
That’s what happened yesterday.
You can see the Death Cross in the chart below as the orange line (50-day) crossed below the red line (200-day).
The markets finished down almost 5% yesterday and the selling may be far from over. The next support level for the S&P 500 is 1,100, another 3.5% lower.
Listen, it’s not that I believe some market magician is going to make stocks go lower because of something called a “Death Cross.”
The reason I am concerned is the widespread belief that this is a bearish sign. Common beliefs like the Death Cross can become self-fulfilling prophecies because of the psychological power they have.
This Death Cross should NOT be ignored.
Some technical indicators can be far-fetched and obscure, but when you have an extremely well-known signal like the Death Cross that screams “SELL,” investors jump onto the bear wagon.
Death Cross Has Company
It’s not just the Death Cross that worries me. The markets have been developing bearish formations for some time.
Another common trait of a bear market is the succession of lower highs and lower lows. When an index like the S&P 500 fails to get above its previous highs and keeps dropping lower, that is a sign of a bear market.
This began happening back in June, but even with the “last hurrah” rally in July, the markets failed to get above its previous highs and then proceeded lower. You can see this in the chart below.
I am concerned about the near future of the stock market. The next month or two will be filled with volatility and bearish pressure, unless there is a dramatic change in economic data, which I do not see happening.
The 200-Day Average Is Now a Huge Resistance Level
What’s worse is that the very level that traders used to look to for support when the market was bullish now becomes a hard ceiling. For the next couple weeks, you can expect the 1,267 level to be a major resistance point. The S&P will have a tough time pushing higher from there. If the market is rallying and we reach the 200-day moving average but fail to close above it, consider selling your long positions.
There Is Hope In This Bear Market
Even with all the bearishness, it is extremely important to identify what type of investor you are. If you are a longer-term holder (over two years), this might be a buying opportunity. Here’s why:
MarketWatch put together some interesting data on Death Crosses over the past decade. Believe it or not, a year after a Death Cross, markets were generally higher.
| Death Cross (Dow Jones) Date | Performance a year later |
| July 2, 2002 | -7.4% |
| July 23, 2004 | 4.2% |
| Aug. 6, 2004 | 7.2% |
| May 19, 2005 | 4.6% |
| Aug. 26, 2005 | 4.0% |
| Oct. 10, 2005 | 8.4% |
| Jan. 3, 2008 | -32.2% |
| July 7, 2010 | 24.3% |
So while things seem bleak at the moment, remember this could be a major opportunity to pick up some quality companies.
Focus on companies with a strong, stable brand, and businesses that will be strong even in economic downturns. Companies like Coca-Cola (KO:NYSE), Johnson & Johnson (JNJ:NYSE), Colgate-Palmolive (CL:NYSE), and McDonald’s (MCD:NYSE) to name a few.
Remember not to panic. Use low-risk, defensive companies, like the ones I have listed, to minimize your stress and volatility in your portfolio during these volatile times.
Remember that there is always more than one solution,
Editor’s Note: In the U.S., there are more than 39 million people on food stamps. That’s enough people to fill every major league ballpark in the country… 27 times over. So what happens when food stamps only buy one-fourth the food they used to? Well, this exclusive report should give you an idea…
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Other Related Topics: Bear Market , Death Cross Trader , Jared Levy , Market Analysis , Moving Average , Option Strategies Weekly
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