You've probably been hearing quite a bit about a possible recession that economists have been predicting for 2008. Some are saying it is already here.
Clearly, the excesses from six years of sub-prime loans and the falling dollar, partly due to lower interest rates, have come back to bite the bottom line of builders and bankers who made those loans. Ultimately, economic weakness will also squeeze the biggest factor in our economy, the consumer. For several years they have benefited from low cost loans to buy everything, but now with heavy second mortgage debt and growing payments to prove it, they are being forced to cut back too.
Regardless of whether we end up in a full fledged recession or just an economic slow down, even a mild bear market could end up draining serious profits from five years of gains out of your retirement accounts. For that reason alone, you should know what steps to take to protect any and all of your investments.
First, going to cash is one simple way investors have tried to avoid losses. It is not usually very successful because in most cases, investors move to cash too late. But here is the point where investors have in my view, been unforgivably misled. No matter what anyone tells you, timing, or knowing when to sell is not impossible or for that matter even difficult, it is absolutely critical to your financial future!
For those who would tell you otherwise, ask them to explain why institutional traders, those who trade for the biggest funds and corporations, and who are responsible for most of the trading volume on Wall Street, move in and out of stocks like clockwork? You have been told to buy and hold because bad timing can end up draining your account too, but more problematically, because your brokerage cannot make much money on fees when you are sitting in cash! It is that simple!
So, if it is possible to know when to exit or buy for that matter, how do you go about it? Let me explain with a little background information first.
No market will ever move in a straight line. Within every trading day, week, month and year, there are multiple mini bull and bear markets. While many theories have developed over the years regarding these waves or cycles, such as the Elliott Wave Theory, it was Charles Dow (of the Dow Jones Industrial fame) who was actually one of the first. He studied profitable wave patterns, and noted how using those to create a timing strategy would dramatically improve profits. He named three of the most profitable waves as the: primary, secondary and short term.
For our simplified discussion here, we will use those three periods and equate them to time frames which have been repeating themselves, with some minor variance, as far back as the 1800s.
For example, the primary wave has been appearing every 48 months or so in our markets. You may sometimes hear it referred to as the Presidential Cycle, since it typically peaks near the presidential election in November, and then turns bearish for two years just after inauguration. In fact, to show you how powerful and persistent that wave has been historically, had you bought stocks two years after each presidential election, and then sold those stocks just prior to the next election, you would have missed every bear market for the past 60 years! That includes the 2001-2002 bear market! By the way, that same wave is due to peak this coming election year (2008) again.
A secondary wave we follow in the market, appears every 8-12 weeks, and may be the most profitable wave of any to play. I refer to it as the intermediate cycle.
You can best see it on your price charts if you look at periodic lows in the market ($INDU), such as those that occurred on 3/20/07, 6/12/2007, 8/17/2007, 11/23/2007, and more recently 1/28/2008. Notice how the period between each of those lows was in the 8-12 week timeframe. Also note how in each instance, a very strong bullish move immediately followed.
Within a bull trending primary wave, the advancing phase of intermediate wave will generally cause markets to climb 12-25% over a 4-6 week period. In cases where the primary trend is otherwise bearish, the intermediate advance may only produce 5-10% gains and become shorter lived as well.
But note how have that information could help you know when its time to buy, and even more importantly, when it is time to sell. If, for example, you knew that an intermediate wave would be peaking sometime in mid-December 2007, it would make sense to lighten up your portfolio for the decline which should occur during the next 4-6 weeks that would follow, right? In that case, the actual decline you would have avoided carved nearly 2000 points off the Dow!
But instead of simply moving to cash during such declines, is there any way to actually profit during such times? The answer is most definitely - YES!
In 2006, a group of Exchange Traded Funds (ETFs) were introduced by ProShares that could be used by investors to profit in weak markets. These are traded just like stock with the exception that they actually increase in value when markets decline! They developed a double beta EFTs as well, which are my favorites to trade, because each of those will move up twice as fast as the markets move down! In other words if the S&P falls 10%, the double beta SDS should move UP 20%!
The symbols for a few of the inverse ETFs are: SDS (S&P), DXD (Dow Ind), QID (NASDAQ).
Returns using double beta ETFs can be very impressive. For example, playing the intermediate wave decline from December 10, 2007, to its low on January 23, 2008, you could have bought the SDS which then moved from $50.90 to $67.80, or a gain of 33% in just six weeks! Now that is what I consider to be a great way to enjoy the downside of any market!
There is certainly a lot more we could discuss regarding additional time frames and strategies for both bull and bear markets using longer and shorter wave periods. But you can find those kinds of ideas and detailed graphs with commentary each morning on my website at themarketforecast.com. By learning to use these, you will begin to see markets in a whole new light. You will know when big volume institutional money is about to change direction in a significant way, and best of all, be able to do something to profit from it. In summary, if you can simply learn to surf market waves, you will avoid getting swamped by their wake.