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How to Invest When Stocks Keep Breaking Down
After a bear market, money tends to sit idle for too long in money market funds. During the recovery from a bear market (i.e. in the early stages of the new bull market), individual stocks rotate. They often break down as the market goes up. Market watchers will announce that the market is up 5% year-to-date, but you might not see it on your own account. Although some individual stocks may rise and fall while others tumble after failed attempts to rise, the general movement of hundreds of stocks is an upswing. For those unsure how to navigate a treacherous market environment like this, ETFs (Exchange Traded Funds) offer ways to participate in the advance even if individual stocks are in a state of severe turbulence.
Most of the time (in normal times), investing in individual stocks can generate much better returns than investing in an index fund. Even when the S&P500 is rising, it will usually have many falling stocks that offset many of the rising ones. Your individual stock picks, on the other hand, can be among the best bargains or among the strongest stocks on the S&P500. You can hear advisors projecting returns of 7% to 10% for the general market (which usually means the S&P500) in the coming years. This return is the net after balancing all losers against all winners. Selected individual stocks within the S&P500 may rise 30% or more over the next year (they may even go from a low to a high of 30% or more more than once over the next year). the year).
Now, let’s reduce the emphasis a bit. Individual sectors of the market are also made up of many stocks. Even when a sector is rising, some of the stocks in that sector may not be rising. Some will be much stronger than average, and some may be in decline. Some of the stocks in the sector may rise rapidly for a short period of time and then dip to give up most of the previous gain. Even if many stocks in the sector crash to lose most of a recent gain, the cumulative effect of all stocks in the sector going through this process at slightly different times will be a generally higher sector.
Therefore, when it is impossible to find good selections of individual stocks or when the behavior of individual stocks is treacherous, investing in index or sector ETFs makes sense. Expert traders have learned the importance of tracking and ranking a wide range of ETFs daily. Why? Even when individual stocks can maintain their trends, it helps to know where the pockets of strength are in the market. When stocks cannot maintain their trends, the scanning process reveals alternatives to individual stocks. How do you know when to use ETFs instead of individual stocks? The question hinges on whether the new market trend has enough internal momentum to support the individual stock trends long enough for them to be profitable. If you buy several stocks a little above the price where there is strong support and the pattern suggests the stock wants to go up, but in each case the stock sells enough to lose all or most of the gain , then it’s probably too early to invest in individual stocks.
For example, an easy way to monitor the development of a new uptrend in the market is to look at the Dow Jones 50-day moving average. If the 50-day moving average is rising and the closing price is above the 50-day average, the index can be considered to be in an uptrend. The angle of ascent of this moving average as well as its consistency can give you information about the strength of the new trend. In a strongly bullish market, the index will stay above the moving average, sometimes rising well above it and sometimes deviating or falling until it encounters the average again. When it hits the middle, it should rebound again into another upward push. If the 50-day moving average is rising sharply, then a good time to enter would usually be when the stock begins an upward push after meeting the average. Experienced traders consider this to be a relatively low risk entry point. Why? It is considered low risk because the support offered by a strong 50-day moving average is nearby, and because the stop loss can be placed near your buy price (just below the 50-day moving average) . The index should dip through the support offered by the average in order to trigger your stop loss. Such penetration would indicate that something is wrong and the position is one you don’t want to keep. To invest in the Dow, a person could buy shares of DIA, an ETF that invests in the 30 stocks that make up the Dow.
Now expand the concept. When the market is down, you can consider investing in the Rydex Ursa no-load fund (Ursa is a “negative S&P500 fund” that rises when the S&P500 falls). Then, when the market is up, you can buy stocks of DIA (the Dow) or SPY (the S&P500) until the individual stocks meet your “buy” requirements or until ‘they start to have tendencies that don’t collapse right away. Either method of using a cash balance should provide better returns than a money market fund. There are a variety of ETFs that can be used when individual stocks are still too volatile even though the market or certain market sectors are in an uptrend. If you are a utilities investor, you can use an SPDR service based on the S&P Utilities (ticker = XLU) just like you can use SPY for a multi-sector account. When the 50-day average (or other indicators you watch) convinces you that the market is in a decline that may persist for some time, you can invest in the Ursa fund or an ETF that goes up when the market goes down. You can short the Dow with DOG, short the NASDAQ with PSQ, short the S&P500 with SH, short the S&P Midcap 400 with MYY, etc. There are also ultra ETFs that seek daily investment results that are double the results of a targeted index. For example, Ultra QQQ ProShares seeks daily investment results, before fees and expenses, that are two times (200%) the daily performance of the NASDAQ-100.
The goal here is not to turn individual stock investors into ETF investors. This is to offer suggestions for investing in a rising market even when it is impossible to find individual stocks in a timely manner, or profiting from a falling market when short selling individual stocks is too risky.
Copyright 2012, by Stock Disciplines, LLC. aka StockDisciplines.com
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