What’s Killing Stocks and What May Resurrect them?

It’s better to be out of stocks wishing you were in, than in wishing you were out. But it’s best to be short stocks when stocks are down. The short trade has worked well, but how much more down side is there?

Every kid knows you better eat your ice cream before it melts. Investors should know to lock in profits before they disappear.

The recent 8.6% drop in the S&P 500 and 12.6% fall in the Nasdaq-100 has certainly done some technical damage and erased a fair amount of profits.

What has caused the market’s sell off and how much worse can it get?

There’s never just one event that triggers a market sell off, but as far as the recent sell off is concerned there’s one reason that weighs heavier than any other: Apple.

Live by the Sword, Die by the Sword

Apple had an incredible run, soaring from $80 in 2009 to $705 in September 2012. Apple became the most valuable company in the world and in the process controlled 20% of the Nasdaq-100 and 5% of the S&P 500.

Apple was like a “dictator of the financial market.” As Apple goes, so goes the market. But that relationship is a two-edged sword, because when Apple sneezes the market will get a cold.

So how was Apple’s health?

According to the Wall Street Journal, “Wall Street analysts are increasingly bullish as Apple hits fresh highs” (August 27, 2012) and MarketWatch wrote “Apple seen as trillion dollar baby” (August 21, 2012).

In contrast, the August 22 Profit Radar Report warned: “The new iPhone will hit the stores soon, a mini iPad is in the pipeline, Apple TV will be in many living rooms near you soon and the holiday season is coming up. Based on fundamentals there’s no reason Apple stock shouldn’t rally, but technicals suggest that a top may be just around the corner.”

This warning was followed up by a specific trade recommendation via the September 12 Profit Radar Report: “Aggressive investors may short Apple (or buy puts or sell calls) above 700 or with a close below 660. Obviously, there is no short Apple ETF and if you don’t have a margin account set up, you may consider using the Short QQQ ProShares (PSQ), which aims to deliver the inverse performance of the Nasdaq-100 (Apple accounts for 20% of the Nasdaq-100).”

Apple has fallen over 25% from its September high and dragged every major U.S. index with it. If you’re looking for a scapegoat, look no further than Apple.

How Low Can Stocks Go?

The S&P started to tread on “thin ice” in late October. Why thin ice? Because it was trading perilously close to key support around 1,400 (see trend lines in the chart below). The thin ice finally broke when the S&P fell through key support at 1,396.

A break of key support is generally a precursor of lower prices, that’s why the November 7 Profit Radar Report stated that: “A move below 1,396 will be a signal to go short with a stop-loss around 1,405.”

The chart below was originally published in Sunday’s (Nov. 11) Profit Radar Report, which included the forecast for the week ahead. Below are a few excerpts from Sunday’s PRR.

“We are short with the S&P’s drop below 1,396. How low can stocks go?

The chart below shows two important levels: 1,371 and 1,346 (updated chart shown below).

Since there’s a good chance of an extended down move, I’m inclined to just let our short position run and see where it takes us. 1,371 is the first hurdle to be overcome to look lower.”

The S&P sliced through 1,371 on Wednesday, and Friday’s trade drew prices as low as 1,343. Since our weekly target has been met we’ve sold half of our short positions.

This doesn’t preclude lower prices, but a bounce is possible and it’s smart money management to eat your ice cream before it melts, or take some profits before they disappear. Continuous target prices and buy/sell levels will be provided by the Profit Radar Report.

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