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By: Chris Rowe — January 19, 2009

Inauguration Marks Doomsday for the Stock Market

Happy inauguration day!

Don't worry, this article is about how to make big profits in the stock market and avoid any further disastrous losses. 

But first I must say that I'm so happy to see Obama being sworn in as he steps much closer to the middle.  I'm glad he seems to have been saying much of what he said (that sounded a bit coo-coo from an economic standpoint) just to get elected.  Fshew!

Now, he seems to be showing that his actions are going to be much more logical and intelligent than his words on the campaign trail.  Thank goodness Obama - You're alright in my book so far.  Keep it up!

Today's swearing-in of the new President of the United States, Barack Obama, will be replayed for many moons so you'll remember many aspects of this part of your life (including the stock market's action, what mistakes you made, how well you could have done, or how well you did).  How will this week's market action make you money?

I'm hoping that, by the time you read this, the market is rallying in celebration of the inauguration because that will give you a great opportunity to get bearish.  But even if the market doesn't rally today, you can jump at the next market rally to take some bearish positions (unless I update you saying things changed significantly).

I've made myself and quite a few investors consistent profits year after year by focusing on one key principle:  "Only trade when the odds weight heavily in your favor."

(It's one of those rules that anyone would smirk at and say "Duh!" after hearing it.  But so few actually follow that principle - believe it or not.  Friends in the business even make fun of me sometimes as they repeat that famous phrase to me, and then chuckle, because they have heard me say it so many times.)

The first thing to understand is that even if you have an 80% chance of being right by following certain principles, you can still be wrong 5 times in a row by playing those odds. 

Having said that, today we are looking at a rare opportunity where the odds are stacked in favor of the market declining some more.  That means you have got to reduce your bullish exposure and increase your bearish exposure. 

Hedge your bullish positions by selling covered calls and/or reducing bullish positions sizes, and if you have no bearish exposure, GET SOME! 

This week may give us a rally that that will be the opportune time to take this action.

You don't have to completely exit your bullish positions - don't go too crazy on either side.  But you definitely need to have bearish exposure right now or else you are driving in the snow with no seat belt on.  Considering the risk (which tends to be invisible, especially in hind sight when everything worked out okay) you're better off exiting the market completely than staying completely bullish.  That statement is true even if the market never trades lower.

When we stack the odds heavily in our favor we look at too many things to mention here.  But we have a few major indications that the market is going down that I'll share with you today ...

One major indication is the activity seen in both the NYSE Bullish Percent Index and the NASDAQ Bullish Percent Index.  I won't get into detail here but these are internal indicators that currently show us that the current trend is that more and more stocks have been joining the bearish party, by moving to sell signals (as opposed to the number of stocks that have been joining the bulls by moving to buy signals).  This is all covered in the Internal Strength System.

What else are we seeing?

I know you've heard the old saying: "The Trend (rider) is Your Friend".   Well when trading the market, you want to focus on three trends:

1. The long-term (major) trend - (Several months to years)
2. The intermediate trend - (Weeks to months)
3. The short-term trend (Days to weeks)

The larger the trend is, the more powerful (and reliable) it is.  That means the long-term trend is the strongest and most likely to continue at any given time.  As a trader, you want to be sure that the next larger trend is in the direction you are trading in.  What does that mean?

If you are a short-term trader (days to weeks), you want to trade in the direction of the next larger trend which is the intermediate trend.  When you are an intermediate trend trader (weeks to months), you want to be sure you are trading in the direction of the next larger trend which is the long-term trend (months to years). 

So what are we looking at today?

The long-term trend is certainly DOWN.  That means the more reliable trend to play, when playing the intermediate-term trend (the next smaller trend), is the down trend.  Sure, there will be intermediate advances and declines, but the point is we know the declines are the better bets to play.  So what we want to do is get bearish after intermediate-term advances.  That's why I'm hoping to see a small, short-term rally to get bearish on.

The intermediate-term trend is also down, although the intermediate down trend isn't that strong.  It's actually been nearly flat for the last few months. 

The short-term trend is down, as you can see, as the market has been declining since the start of the year. 

The intermediate-term trend has been declining, but not in a strong way, which is understandable after the market dropped 50%.  Such a large decline takes time to "digest".

(Again, if you are interested in learning how to gauge the risk and reward of any market situation, check out The Internal Strength System by clicking here.)

What else are we seeing that says the market goes even lower?


6-month daily chart (click it to enlarge)
 

Clearly, the 900 level on the S&P 500 has been a key level, as it acted as support a few times in October and November.  Once it was violated in November, it became the new resistance level.  (Notice the small blue dots and horizontal green line).

I circled the one time where the index managed to climb above 900 in a somewhat meaningful way, but that only produced reversal patterns followed the current decline. 

Still looking at the chart above, you can see the diagonal (blue) up trend line was violated at that point (a bearish signal) which was followed by a MACD sell signal (red circle).  These are all bearish signs. And while there are some bullish signs, we have to go with what the majority of clues are pointing to: A LOWER MARKET.

Now zoom out and look at the chart below which is a 2-year chart of the S&P 500 (and I know this article is long but this is way too important to stop reading here...) 

2-year daily chart (click it to enlarge)
 

You can see that the widely followed 50-day moving average is a key trading point too.  The red arrows show that, since the beginning of 2008, the 50-day moving average has acted as a resistance level (red arrows) with the exception of April and May when the market briefly peaked above it (blue arrow).  However as soon as the market moved below it again, it declined about 15% in a month and a half.  Check out what happened when the market tried to rally above it at the turn of the year (just 3 weeks ago).  Viva La Resistance!

It would be awesome if the market could move back up near the 50-day moving average again, giving us a perfect time to reduce bullish exposure and increase bearish exposure. 

IMPORTANT:

As I said, even if there is only a 10% chance that the market's next major move is up, it could happen!  I'm telling what the ODDS FAVOR right now.  So you have to play the odds every time when they are strong, and when we are wrong, we are wrong, and we are hedged.  

But what if I'm right?

There are two versions of Chris Rowe being right about this.

VERSION 1:  The market moves about 10% lower and makes the double bottom that we will almost definitely see whenever a major bottom is created.  The market has not even made a double bottom yet, which adds more probability to the scenario of the S&P 500 declining to the 752 level again.  In "version 1" we get an intermediate rebound at about 752 and then the market tries to advance in a meaningful way. 

VERSION 2:  The market makes a nosedive that will send fear levels to outer space. 

WOW - Why so doomsdayish?

This is easy for any first grader to see.  A picture's worth 1,000 words ...


39-year weekly chart (click it to enlarge)

For those who don't see it already, I'll explain. 

The green line and red arrow shows that the market is right at its 2002 - 2003 bear market low.  That means if that level is violated, there is no real known support level.  You'll hear people tell you what they interpret as the "next level of support" but the truth is it's anybody's guess.  The market could drop much further from here - believe it or not.

THAT'S WHY YOU ABSOLUTELY MUST HAVE BEARISH EXPOSURE HERE - EVEN IF YOU THINK THE MARKET TRADES HIGHER.  It's a smart insurance policy - forget whether the odds are stacking on the bear side or not!

The hedge fund industry has been absolutely torn apart.  It should be halved from its peak soon if it hasn't happened already.  The hedge funds have been the main players in this game and they have kept markets efficient, they've provided liquidity to the markets and have been the ones willing to take big risk.  However, that's all changed to a large degree.  That means the market, as we have come to understand it, has changed. 

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