ARE YOU READY FOR THE NEXT MARKET MELTDOWN? / BARRON´S MAGAZINE

Getting Technical

Are You Ready for the Next Market Meltdown?

By Michael Kahn


Photo: Getty Images/iStockphoto



Stocks may be in the melt-up phase in this nine-year-old bull market, but whatever we call it, investors must always prepare for the worst.

And at the same time, they must also be ready for the best.

There is plenty for bulls to like right now. Market breadth is strong; there is no traditional chart resistance overhead; money continues to flow into stocks and exchange-traded funds; and markets around the world are strong, if not in all-time high territory.

Fundamentally, things look good, too. On Thursday, the initial jobless claims number dropped to a 45-year low. Auto makers have committed to big investments in the U.S., and businesses seem to be responding well to recent tax and regulation reform.

Of course, the bulls seem to be downright giddy about it. The level of bullishness is in extreme high territory, according to surveys from Investors Intelligence and the American Association of Individual Investors. That usually does not end well—when “everyone” is bullish, theoretically there is nobody left to buy. Demand dries up and one spark can send the herd stampeding toward the exit doors.

One look at the Standard & Poor’s 500 index shows the rally accelerating yet again (see Chart 1). Some call it a parabola, and we can see it as each trendline steepens.



Chart 1

Parabolas are dangerous, but not just for bulls. They can last far longer than people expect, and when they finally do turn, it happens quickly. Timing must be perfect because being off by just one day—long or short—can result in big losses. Just ask cryptocurrency traders.

So what’s an investor to do? It seems odd that a market timer such as me would say that timing the market right now is too difficult. But that does not mean you cannot take steps to cushion the blow when the correction eventually happens, without selling everything now and fortifying your bunker.

First, look at the long-term trend that defines what kind of market it is. Right now, secular and cyclical trends are rising (see Chart 2). We can argue whether the current bull market began at the 2009 low or when the S&P 500 broke out from its 1997-2013 trading range. Regardless, the index now trades above its 200-day moving average, and for many investors that is all we need to know about the major trend.


Chart 2

True, the market is as far above that average as it has been in years, but touching it would amount to only a 5% dip. I imagine almost every analyst would welcome such an event and call it healthy. If you can handle that size correction, then you can be comfortable that the bull market is still intact. Overbought, yes, but intact.

Next, not all stocks are created equal. Some of them lead while others lag. We can exploit the characteristics of these two broad areas because weaker stocks tend to fall harder when the market declines. The current rally may have just swept them along for the ride, but they do not have the capacity to weather any storm that will eventually appear.

It wouldn’t hurt to look at a portfolio and prune the weakest members. You can determine what those stocks are any way you like. Relative performance on charts is a great method, but weak balance sheets, lack of sales growth, or even a low score from a ratings agency can be your filter.

It also would not hurt to take some money off the table even as the market roars higher, Thursday’s action notwithstanding. Selling portions of a position along the way allows you to take out your original investment and lets your profits ride. How much and when is a personal decision, but why not turn a little of your paper profits into real cash in the bank? I bet bitcoin investors wished they did some of that when that market topped $19,000.

Finally, know your “uncle” point, because all the analysis in the world cannot stop a market that has changed from bullish to bearish. It could be a stop loss at 10%. It could be the break of a technical feature, such as a trendline or major chart support.

For the S&P 500, a 10% drop would take it down to the trendline drawn from the start of the current leg of the bull market in February 2016. Below that, we would have to concede that the bears have, in fact, taken over.

The point is to have a plan and know what you will do if and when something happens.


On a Personal Note

This is my last column for Barrons.com after nearly 17 years. It’s been quite a ride, and I’ve enjoyed being affiliated with a top-notch financial outlet and a host of excellent writers and editors.

Over the years, the markets have changed, and technical analysis has had to adapt. Yet people still do similar things when faced with similar circumstances—and charting remains an excellent way to figure out the markets and what you should do about it.

But with so many ways to express bullish and bearish opinions (stocks, options, ETFs, funds) and the ability to find, research, and execute trades in minutes, many of the tried and true indicators and techniques don’t work quite the same way they did when they appeared on the scene decades ago.

Volume analysis was a big victim of the explosion of alternatives to stocks. So were many intraday analyses, such as money flow and tick, and that was made even worse when trading moved from eighths to pennies.

But we move on, using indicators with a grain of salt and always remembering that price action alone is king. Everything else plays a supporting role.

And with that, farewell, dear readers. I hope I was able to enlighten.


Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.