Using Support As Risk Management Tool

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It is too early to get overly concerned about the intraday weakness we have seen in recent sessions. However, it is not too early to have contingency plans in place should outcomes skew toward the bearish end of the spectrum.

Muted Response To Fed

The lack of response from commodities and precious metals to Wednesday’s “we will print as long as necessary to bring down unemployment” announcement from the Fed is a yellow flag for investors. It tells us the markets are losing confidence in central banker’s ability to create positive inflation in the face of strong deflationary forces. Sometime over the next two weeks we would like to see commodities and precious metals attract interest from buyers concerned about future inflation.

Important To Have Contingency Plans

In our videos, we often talk about “drawing lines in the sand” or “clearing thresholds”. If you manage investments with an “If-then” type of approach, it provides milestones for making decisions. At the early stages of a correction or bear market, indecision can be very costly.

Given the weak stock market closes on Monday and Tuesday, we believe it is prudent to identify “leave it alone” regions and “time to take some defensive action” regions. While we make allocation decisions based on our market models and the big picture, understanding simple support and resistance levels is essential to proper risk management.

S&P 500 Support

The chart below shows possible areas of support for the S&P 500 based on numerous methods and timeframes (monthly all the way down to a 5-minute chart). Fibonacci retracement levels, based on the “down” move from B to C, are shown in blue (1393, 1408, and 1424). The retracement levels for the “up” move from A to B are highlighted via the three green horizontal lines (1346, 1370, and 1395). An updated version of the chart below can be viewed during the remainder of the week here.

spx 12 dec 2012

If-Then Scenarios

If the S&P 500 drops into the 1408 to 1424 region, our bias would be to “leave it alone”. If the big picture deteriorates above 1408, we may consider adding a relatively small hedge to our portfolios (e.g. a drop accompanied by significant strength in defensive assets).

Our concerns would increase between 1393 and 1408, but our overall bias would still be an expectation of another move higher in stocks. If the S&P 500 drops below 1393 and is accompanied by other big picture bearish indications, we would most likely add a hedge and/or cut back on our exposure to risk (do some selling).

Market Leaders As Risk Monitors

A simple tenet of markets is when market leaders are healthy; the market tends to be healthy. Conversely, when market leaders stop leading, it is time to become more concerned. If the following ETFs can continue to exhibit strength, it sides with the bullish camp for global risk assets: Mexico (EWW), Germany (EWG), France (EWQ), Euro Stoxx 50 (FEZ), China (FXI), Emerging Markets (EEM), and Asia (AAXJ). We will also be keeping an eye on credit spreads in the days ahead.

If Fed Assets Catch A Bid

The Fed is trying to create positive inflation, including asset price inflation to encourage economic activity based on the “wealth effect”. If the Fed is successful, stocks and commodities should continue to perform well. These ETFs can assist with monitoring the effectiveness of the Fed’s printing extravaganza; silver (SLV), metals and mining (XME), semi-conductors (SMH), Australia (EWA), Latin America (ILF), Brazil (EWZ), Russia (RSX), and commodities (DBC).

Source: Ciovacco Capital

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