David Gillie is a Contributing Editor and subscriber to the ETF Digest.
He has been an Engineering Consultant for multi-million dollar construction claims, President and Founder of Envirospec, Inc. (Robotic Pipeline Inspection Equipment) and owner of David Gillie Woodworking & Design.
He divides his time between Wilmington, North Carolina and Fort Myers, Florida.
Don’t panic—just be prepared.
Pullbacks are a healthy function of the market. They allow new investors to come into a rising market and signal profit-taking for smart money.
Timing a pullback and protecting your portfolio is of the utmost importance. What you don't want to do is just sit and watch your portfolio value sink. So, first let’s look at timing a pullback.
Directional changes frequently occur at the intersection of trend lines. As seen when the upper channel (green dashed line) was intersected by the long term trend (blue dashed line) at the end of October, and again when the long term trend line intersected with the mid channel (orange dashed line). By projecting outward at the current trajectory, we see that the upper trend line (blue dashed) is about to intersect the lower channel line (red dashed) in the next few days.
A trend line cross above the price is more predictable than a trend line cross below the price. It is possible for this formation to result in an explosive move upward in price. To anticipate better directional price movement at the intersection, we have to look deeper into present conditions.
During the first week of 2012, the price of the S&P 500 stalled at the price resistance level around 1280 (green horizontal line). We broke through this price resistance this past week, but stalled again. Friday's price action formed a hammer candle stick – typically a bullish formation. However, in this case, it’s a red hammer, which often fails. Additionally, the tail of the candle stick pierced support indicating weakness. Weakness was confirmed by the light volume. This gives us two bearish conditions on a bullish candle stick. Not encouraging.
Mid channel support/resistance (orange dashed line) is an often overlooked inflection point in technical analysis. We can anticipate the price of the S&P to hit this level around 1310. That should also coincide with the intersection of the upper trend line and lower channel line as described above. Also, throw options expiration on January 21 into the mix, which tends to throw the market into a tizzy. Mid week next week is a likely inflection point. Okay, that covers timing.
Now let’s look at how we protect our portfolio. First and foremost, don't leave profits on the table. Remember, you can always buy it back again if you jumped the gun, but you may not be able to sell (at this price) again if you missed the move. Or, let’s put it this way... nobody ever went broke taking a profit. We have two events to signal profit taking forming: 1) Price hitting mid channel resistance; 2) trend line intersection. You may not necessarily have to capture the last dime of this recent move. Even if the market continues up after you take profits, you'll still have your initial investment in to continue the move.
Now we move to the next level of protecting your portfolio and even profiting by a pullback. There are numerous ways to accomplish this but let’s look at the most simple way via long term Treasury ETFs. Treasuries tend to move in an inverse correlation to equities. Therefore, we're going into a "long" position as opposed to the much higher risk of shorting. We are not seeking yield from Treasuries, but rather a short-term capital gain. There are two ETFs that will best accomplish this goal: iShares Barclays 20+ Year Treasury Bond ETF (TLT) and, the leveraged issue of the same ETF, (TMF). Treasury ETFs tend to be the most "forgiving" of the hedging positions if you don't time your hedge just perfectly.
Another inverse correlation to equities is the Volatility Index (.VIX). Traders will sell calls and buy puts for downside protection. This causes the VIX to rise. Again, rather than shorting, we can take a long position in the VIX.
There are two established levels of the VIX that we pay close attention to: 30 (green horizontal line), which above that is considered fear in the market, and 20 (red horizontal line), which is considered complacency when the VIX falls below that level. We just took a second bounce off the important 20 level and moved up this week. When the VIX moves, it goes up much faster than it goes down. Therefore, you need to be in your position before the move. Also, the VIX may make the extent of its move over a relatively short time, maybe just a week. Over the past six months, we've seen very unusual levels on the VIX. Barring a collapse in Europe or war in the Middle East, the VIX would likely move up to 30 as a norm. There are several ETFs that track the VIX, but we'll look at just two—the most heavily traded issues.
The iPath S&P 500 VIX Short Term Futures ETN (VXX) has an average daily volume of over 18M shares. This is a very liquid position and closely tracks (not exactly) the VIX. You could also consider the leveraged issue, VelocityShares Daily 2x VIX Short Term ETN (TVIX), which has an average daily volume of 3.6M shares. If you take a position in one of these VIX ETFs, it would be prudent to set your sell price to correlate with 30 on the VIX. Some brokerages will actually allow a conditional order to place the sell trigger on another equity or index.
Overall, the US economic data has been somewhat better. Not great, but good enough so that there doesn't seem to be a sense of fear or panic in the market. This is why we are not expecting a major sell-off or a radical spike on the VIX should we see a pullback.
David Gillie is a Contributing Editor and subscriber to the ETF Digest.
He has been an Engineering Consultant for multi-million dollar construction claims, President and Founder of Envirospec, Inc. (Robotic Pipeline Inspection Equipment) and owner of David Gillie Woodworking & Design.
He divides his time between Wilmington, North Carolina and Fort Myers, Florida.
Don’t panic—just be prepared.
Pullbacks are a healthy function of the market. They allow new investors to come into a rising market and signal profit-taking for smart money.
Timing a pullback and protecting your portfolio is of the utmost importance. What you don't want to do is just sit and watch your portfolio value sink. So, first let’s look at timing a pullback.
Directional changes frequently occur at the intersection of trend lines. As seen when the upper channel (green dashed line) was intersected by the long term trend (blue dashed line) at the end of October, and again when the long term trend line intersected with the mid channel (orange dashed line). By projecting outward at the current trajectory, we see that the upper trend line (blue dashed) is about to intersect the lower channel line (red dashed) in the next few days.
A trend line cross above the price is more predictable than a trend line cross below the price. It is possible for this formation to result in an explosive move upward in price. To anticipate better directional price movement at the intersection, we have to look deeper into present conditions.
During the first week of 2012, the price of the S&P 500 stalled at the price resistance level around 1280 (green horizontal line). We broke through this price resistance this past week, but stalled again. Friday's price action formed a hammer candle stick – typically a bullish formation. However, in this case, it’s a red hammer, which often fails. Additionally, the tail of the candle stick pierced support indicating weakness. Weakness was confirmed by the light volume. This gives us two bearish conditions on a bullish candle stick. Not encouraging.
Mid channel support/resistance (orange dashed line) is an often overlooked inflection point in technical analysis. We can anticipate the price of the S&P to hit this level around 1310. That should also coincide with the intersection of the upper trend line and lower channel line as described above. Also, throw options expiration on January 21 into the mix, which tends to throw the market into a tizzy. Mid week next week is a likely inflection point. Okay, that covers timing.
Now let’s look at how we protect our portfolio. First and foremost, don't leave profits on the table. Remember, you can always buy it back again if you jumped the gun, but you may not be able to sell (at this price) again if you missed the move. Or, let’s put it this way... nobody ever went broke taking a profit. We have two events to signal profit taking forming: 1) Price hitting mid channel resistance; 2) trend line intersection. You may not necessarily have to capture the last dime of this recent move. Even if the market continues up after you take profits, you'll still have your initial investment in to continue the move.
Now we move to the next level of protecting your portfolio and even profiting by a pullback. There are numerous ways to accomplish this but let’s look at the most simple way via long term Treasury ETFs. Treasuries tend to move in an inverse correlation to equities. Therefore, we're going into a "long" position as opposed to the much higher risk of shorting. We are not seeking yield from Treasuries, but rather a short-term capital gain. There are two ETFs that will best accomplish this goal: iShares Barclays 20+ Year Treasury Bond ETF (TLT) and, the leveraged issue of the same ETF, (TMF). Treasury ETFs tend to be the most "forgiving" of the hedging positions if you don't time your hedge just perfectly.
Another inverse correlation to equities is the Volatility Index (.VIX). Traders will sell calls and buy puts for downside protection. This causes the VIX to rise. Again, rather than shorting, we can take a long position in the VIX.
There are two established levels of the VIX that we pay close attention to: 30 (green horizontal line), which above that is considered fear in the market, and 20 (red horizontal line), which is considered complacency when the VIX falls below that level. We just took a second bounce off the important 20 level and moved up this week. When the VIX moves, it goes up much faster than it goes down. Therefore, you need to be in your position before the move. Also, the VIX may make the extent of its move over a relatively short time, maybe just a week. Over the past six months, we've seen very unusual levels on the VIX. Barring a collapse in Europe or war in the Middle East, the VIX would likely move up to 30 as a norm. There are several ETFs that track the VIX, but we'll look at just two—the most heavily traded issues.
The iPath S&P 500 VIX Short Term Futures ETN (VXX) has an average daily volume of over 18M shares. This is a very liquid position and closely tracks (not exactly) the VIX. You could also consider the leveraged issue, VelocityShares Daily 2x VIX Short Term ETN (TVIX), which has an average daily volume of 3.6M shares. If you take a position in one of these VIX ETFs, it would be prudent to set your sell price to correlate with 30 on the VIX. Some brokerages will actually allow a conditional order to place the sell trigger on another equity or index.
Overall, the US economic data has been somewhat better. Not great, but good enough so that there doesn't seem to be a sense of fear or panic in the market. This is why we are not expecting a major sell-off or a radical spike on the VIX should we see a pullback.
You may recall an article I wrote on TLT with two new year's resolutions:
1) Don't leave profits on the table
2) Hedge
Since you've probably already broken your diet and exercise pledges, there's still time to keep your new resolutions.
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