The two key numbers you must watch out for on the US stock market

By Dominic Frisby Aug 25, 2010

Dominic Frisby

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I am becoming increasingly worried about global stock markets. I'm starting to think we may even have another rout on our hands.

So today I want to take a look at the technical action of the market, and consider where we might be headed next.

I have been saying since April that cash is the place to be. And, I'll warn you now, my opinion hasn't changed. The action I am seeing is ugly – and I'm concerned it could get uglier...

Why long-term investors should stick with gold and cash

We are in a phase of manic swings. Capitulation is followed by rally which is followed by capitulation. It's not healthy for the nerves, let alone the economy.

Using America's S&P 500 as a proxy for global stock markets, we saw sharp falls in January, then a terrific move of more than 15% from just above 1,040 in February to 1,220 by late April. Barely a few days and a 'flash crash' later, all those gains were given back and we were at 1,050 again.

In May, another rally took us back above 1,150, but we soon saw 1,040. In June we got another rally to 1,120, then we were back down at 1020. The remarkable July rally – some 10% – skewered the bears.

But this month it's been the bulls' turn to be hammered. This last week has been particularly ugly, with yesterday no exception. We are now back in the 1,050 area.

This volatility is breathtaking. It's great if you have an effective technical system with which to play it – and there are many traders who thrive on this. But it is extremely hard to get it right consistently. What's more, you need excellent money management so as to minimise your losses when you get it wrong.

This is why I have been advising the longer-term investor since April to stick with gold and cash. There's nothing wrong with trying to play the markets, but don't kid yourself that it is anything more than speculation.

Watch these two numbers

I see the next few days as possibly pivotal. As you can see from the chart I have drawn below, 1,040 is an area where the S&P 500 has consistently found support in the past. The same goes for the 1,020 area. Both are marked by dotted black lines.

If they do not hold – and eventually I suspect they will subside, such is the selling volume – 1,020 and then 1,040 could quickly become barriers which the market struggles to get through on any subsequent rallies.

It wouldn't surprise me if there are a lot of stops just below those levels. These could easily be triggered should the market get to them, causing a further acceleration in the slide.

The 20 and 50-day moving averages have all turned down. Unless the market stages a big rally here, the 200-day is about to as well. The larger trend, despite all the volatility, is very much down, as the large blue channel I have drawn shows.

I have to say, as I have observed before, all these swings are eerily reminiscent of the lead-up to the crash of 2008. Crashes are such rare occurrences (there have been, I think, five in the last 100 years) that the laws of probability don't warrant betting on them happening. But a case could actually be made for one here, if those pivotal points I have outlined above don't hold. All we need is some major event, along the lines of the Lehman Brothers bust, added to this awful technical action, and a full-scale panic could easily be triggered.

How investors can play these volatile markets

There are various exchange-traded funds (ETFs) that enable you to play the short side of the market. And of course you can always spreadbet (use our spread betting comparison table to find a provider if you're tempted to go down this route). But, and this particularly applies if you are using any form of leverage, you have to be nimble. The short covering rallies to the upside can be devastating – and I wouldn't be surprised if we get one from 1,020 or 1,040.

For my part, I am looking for a tradable low, perhaps around October. It is normal in the second year of a US presidency to get a low some time late in the third or fourth quarter. I believe that low lies ahead of us. The best strategy remains, as I keep saying, to sit patiently in cash and wait for a better buying opportunity to present itself, as I'm sure it will, in the months ahead.

And of course, I'm happy to stick with gold. On that front, I have some news – I've put together a new gold report which will be available very shortly. To give you a sneak preview, it explains how to buy and sell gold, updates on last year's tips, uncovers some new and exciting gold mining plays – and I also reveal the best strategies for playing silver, gold's somewhat frustrating little sister.

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Missing parcels in South America and security threats at home mean big opportunities for these two London-listed penny share plays, says Tom Bulford.

Comments (11)

Published in Stock markets | More articles by Dominic Frisby

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  • 1. SH

    (25 August 2010, 10:46AM)  Complain about this comment

    good analysis, thanks. Throw in the spectre of the, now confirmed, Hindenburg Omen and certainly time to walk with a guard up!

  • 2. Stephen B

    (25 August 2010, 11:00AM)  Complain about this comment

    Markets seem to be responding now to the Fed's refusal to start the printing presses again. The key to playing the volatility is to try and guess Bernanke and his colleagues at the Fed. The long-term is down, but I don't see another crash, just a drawn-out decline, punctuated with short rallies, ala Japan.

  • 3. David h

    (25 August 2010, 11:28AM)  Complain about this comment

    If the printing presses do start to roll again, this will herald an even bigger crash sometime in the future. If you hold equities and wish to keep them, offset with a little short of a major indices. This will mitigate your losses if we encounter violent moves.
    I suspect the presses will roll again soon, as Marc faber says “Mr Bernanke is a money printer” the US exports $ and with them misery to the rest of the world. So if you chose to hold cash take care with the green back!

  • 4. Stephen B

    (25 August 2010, 11:58AM)  Complain about this comment

    Obama and Bernanke won't start the presses before the mid-term elections, it would give too much leverage to the republicans and the tea party movement. I think the fortunes of the market are more tied to politics than any time in my memory.
    Like Dominic says, gold is the only currency that can't be printed. The US dollar will nevertheless enjoy a rebound with a fall in the markets, and as the forces in the US economy are overwhelmingly deflationary, I only see the dollar appreciating from here, until the Big One.

  • 5. Mike

    (25 August 2010, 12:50PM)  Complain about this comment

    Beware Short ETF's volatility kills these are they are compounded daily so you pay for any daily move up, to profit from a downward track it is best for it to constantly down. i.e with daily compounding if the market goes down one day and returns to were you bought the short the next day you will lose money, but if the market just stays in the same place you will be even.

    We are in volatile times!

    Oh and I am still sat on my FTSE short and I am not in the money.

  • 6. Adam Clark

    (25 August 2010, 01:38PM)  Complain about this comment

    If the next two months were to see a stock market crash, then gold could well be sucked down (albeit temporarily) in the downdraught. This happened in 2008 and will probably happen again. I agree that October should be a good month to enter/re-enter the stock or gold market.

  • 7. Stephen B

    (25 August 2010, 05:37PM)  Complain about this comment

    Unless you uncover some small cap gems, I don't see much point in being in equities at all this or next year as a retail investor. The trend is firmly downwards, even for 'defensive' shares - it all goes down together. I would wait until the process of consumer deleveraging is over, which could be five, maybe ten years from now. The only hope for equities is if emerging markets decouple, and create vibrant consumer markets for western companies. I think this is on the cards in ten years time, which is why I'm very optimistic for stocks around then. But in the meantime I'm just playing the market for volatility, keeping the rest in cash and gold.

  • 8. Stocks72

    (25 August 2010, 06:42PM)  Complain about this comment

    No, I still believe that we will see a rebound in stock markets this year and also that the gold price will fall in fourth quarter 2010

  • 9. NVP

    (26 August 2010, 08:09AM)  Complain about this comment


    I have no idea how stocks work

    But if Equities plunge buy CHF,YEN and USD

    and buy the others as they become fashionable plays

    NVP
    Ps- Dominic - hows the sell yen going ?

  • 10. NVP

    (26 August 2010, 08:12AM)  Complain about this comment

    Sorry

    in previous comment I meant sell the other currencies..(naturally)

    to many screens up and distractions at present

    NVP

  • 11. w2w

    (26 August 2010, 03:13PM)  Complain about this comment

    http://www.bespokeinvest.com/thinkbig/2010/8/25/sp-1500-short-interest-unchanged-since-april.html

    Little if any fuel for a short covering rally it seems.

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