Do you sell or ride out bear market?
thestar.com
A simple trend line can be the best technical tool to determine direction of a volatile stock market
Aug 17, 2007 04:30 AM
Bill Carrigan
special to the Star
Don't worry about a thing, 'cause every little thing gonna be all right. – Bob Marley, "Three Little Birds"
I don't think Bob Marley had a bear stock market in mind when he wrote "Three Little Birds" in the late 1970s. The big worry back then was the Arab oil embargo and the sobering fact we in North America were dependent on "foreigners" for oil.
The monster bear market of 1973 and 1974 riffled few feathers because most of the young working middle class was preoccupied with home ownership, children and job security.
The stock market was for rich old people.
In the mid-1980s, a new bull market changed everything. The new bull introduced the wealth management industry that in turn attracted a new breed of investors – poor young people who aspired to be rich young people.
The monster bear of 2000 to 2002 riffled a lot of feathers because we all owned some stock or mutual funds and the big worry was the sobering fact that a bear market could also threaten other stuff like property values and job security.
The subsequent bull of 2003 to 2007 saw many of the broader world indices advance to new highs, and for the most part, all damage from the 2000-02 bear was repaired.
Last month, all was good as the Dow Jones industrial average hit 14,000 and the S&P/TSX composite index hit a record close of 14,625.76. Then suddenly, the bull trap.
A bull trap occurs when prices break above a significant level and attract bullish investors, creating a bullish stampede.
The euphoria ends quickly as prices suddenly reverse course and trap the bulls, who panic and hit the sell button.
Bullish and bearish stampedes are no longer the exclusive activity of private investors due to the growing number of young inexperienced portfolio managers who have never experienced a full-on bear market.
In bear markets, nothing rational seems to work. Fundamental analysis – looking for cheap stocks to invest in – doesn't work, because both cheap and expensive stocks fall in price. In many bear markets there is nowhere to hide and the duration and magnitude of a bear is difficult to predict.
In most cases, the only protection against the bear is to sell and let the beast have its way.
So investors call on the technical analysts to answer the question on everyone's mind. Do I sell now, or do I hang in for the long term?
What is the best technical study that works during difficult markets?
I have found that simple moving averages, multiple moving averages, momentum, spreads, price channels and volume studies do not work all the time.
Squiggly lines when applied to stocks and indices in most cases only serve to confuse. A simple well-placed trend line is the best technical tool.
A trend line is a straight line drawn on a chart below reaction lows (in an uptrend) or above rally peaks (in a downtrend) that determine the steepness of the current trend. When the price breaks a trend line this usually signals a trend reversal.
Our chart this week is that of the weekly closes of the S&P 500 spanning from mid-2004 to now. I have placed a primary trend line (the longest line) joining the lows of mid-2004 and mid-2006 and (important) extended the trend line to the extreme right of our chart.
I then placed a secondary trend line (the shorter line) to join the mid-2006 low and the higher March 2007 low.
Eventually most trend lines – no matter how long – will be broken, as evidenced by the break of our secondary trend line during the recent collapse of the S&P 500 from the July peak of 1,555.
At the moment, the loss from the July peak is about 10 per cent and a rebound up from this level would be a reasonable assumption.
This retracement from an oversold condition is an advance that retraces a portion of a previous decline. A retracement can typically cover one-third to two-thirds of the previous move, and so a rebound toward 1,500 is possible. This would be a "feel good" rally and cause many investors to regard the sell-off as a buying opportunity.
Any subsequent decline could take the S&P down to the lower primary trend line and that would be our bear market price target.
If that were to occur, the magnitude of the drop (peak to target) would be 1,555 to 1,360, or about 12.5 per cent.
If you are currently invested, you may be too close to the target to sell – if you hold.
Keep that straight edge handy. |
