Hard to believe that just six years ago the Dow Jones Industrial Average hit rock bottom. Headlines in the paper jumped off the front page, screaming the major index touched 6,547 in bold lettering, a price level not seen since the mid-90s!
It made anyone with skin in the game sick to their stomach, especially for those with sizeable equity allocations on the verge of retirement. While the steep drop from 14,164.53 on October 9, 2007 didn’t exactly happen overnight, it’s safe to say that most investors believed any pullbacks would be short-lived.
We inevitably wondered whether or not the bleeding could be held in check to prevent a complete collapse of the financial system and a run on banks – something many of us remember only to have existed a hundred years ago in the history books.
It certainly felt like the end of times…
But as we all now know, the Great Depression of this generation was put on the back burner when our government rode in to the rescue with investments to shore up consumer and business sectors where spending had been in full retreat. Despite a seemingly potent market recovery, we’re not out of the woods just yet. Many of the underlying issues that brought the market to its knees in the past have not been fully resolved. But the good news is that there is money to be made in any type of market, even if it’s a bullish one built on fluff.
With that on the mind, let’s see where we’ve been, where we are and what will happen next…
In the chart further below, you’ll notice the steep DJIA drop, followed by the 2009-present market recovery. Our focus will be on two parallel white lines that resemble a set of train tracks. Think of the top as a ceiling and the bottom as a floor, two barriers that contain price movement and keep things moving forward in a predictable “big picture” manner.
This important channel formation is a common pattern in the charting world which serves to give warning when a security or index is pivoting in preparation for a trend change. The steeper the climb, the more potent a breakdown becomes when bullish momentum sputters and fear takes hold.
The DJIA is currently climbing on a 45-degree angle trajectory which can be maintained for a considerable length of time. And as you can tell, we’ve been on the march for the better part of a decade now. But this bullish situation will eventually give in to downward pressure, and it will end badly for those who fail to spot their profit-taking window.
If you were to pull up a chart of the S&P500 on the same longer-term time span, you’d see the same channel formation. Since this particular equity index is a leading indicator of U.S. equities there will likely be evidence of momentum deterioration prior to the Dow following suit with a drop below the bottom channel line. But for the time being there is currently no evidence to suggest this to be the case. Hence, prices should continue to rise higher into the foreseeable future, testing bottom support only on occasion.
With that said, there are many ways to play this setup, depending on what type of investor you are.
If you’re a long-term equity holder, you’ll want to continue riding the bullish wave while the wind is still at your back. But if prices on a monthly price chart such as this one fall below the bottom parallel line, it’s time to drastically reduce equity exposure and perhaps look into investments that would allow you to benefit from the downward price pressures to follow.
For example, there are many bear market investment vehicles, outside of individual equity positions, that can shield a portfolio and from downward pressures and actually position you to profit from it. ETFs such as the ProShares Short S&P 500 (SH) or UltraShort S&P 500 (SDS) should do the trick. There are different degrees of correlation so be sure you know the level of risk you’re taking as some will move 3x in the opposite direction of the S&P500, for better or worse.
On the other hand, traders will want to work within these parallel tracks, buying on the low end of the channel and selling closer to upper resistance in a repeated fashion. The party ends as soon as price breaches and begins to trade outside of the channel.
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