Stocks Break Down

The Market is Rising but Stocks Keep Breaking Down

By Dr. Winton Felt

The market appears to have changed from being a declining market to being a rising market. Day after day, reporters announce that there has been another market advance. Yet, it may seem that every time you invest in a stock it breaks down and your stop loss is triggered. It is not always easy to participate in a new uptrend. During the transition from a bear market to a bull market, is parking your assets in a money-market fund really your best option? Here are some alternatives..

In the transition time, when the market appears to be in the beginning phase of a new up-trend after a prolonged decline, we may hesitate to invest until we have more assurance that the trend is likely to endure awhile. In the early stages of a recovering market, we may be slower to invest than we could be. There is a good reason for this. Those who carefully monitor stock behavior during these times may notice that an inordinate number of stocks break down and collapse after attempting to reverse course. Even though the market seems to be recovering and indexes are rising impressively, individual stocks are churning. During a recovery after a bear market, stocks may make a big rise and then fall enough to lose almost all the gain. Only those who bought at the very beginning of the price surge can make a profit under those conditions. Most investors will not do that, so they will lose on their trades. When thousands of stocks alternately rise a little then plunge to give up most of the previous gain, the overall market may look good as it rises steadily to higher valuations. In the meantime, though investors may hear that the market is up 12% year to date, they notice that their own portfolios are down 5%. Thousands of stocks are taking turns at pushing the market a little higher. Even though the percentage of breakdowns is high, the combined effect is a rising market. During times like this, when individual stock breakdowns are relatively frequent, the volatility (and risk) of individual stocks is much greater than that of the market as a whole. Thus, many investors move assets to the money-market while the market as a whole is making gains that are much more attractive.

Individual stocks do not always evidence this level of instability in the early stages of a market turnaround. However, when they do, I suggest that investors and traders evaluate whether or not it would be wise to make the following “tweak” to their discipline. During the waiting period between the time when the market turns bullish and when you begin to take positions in selected stocks, you might be able to further enhance returns by investing in the market as a whole. There is a security (symbol = SPY) that tracks the S&P500. It is an exchange-traded fund (ETF) also known as a SPDR (Standard & Poor’s Depository Receipt). Our own stockdisciplines.com traders track SPY and a large number of other ETFs daily and rank them relative to each other. They make this part of their daily discipline because it gives them the information they need to participate in the market even when individual stocks are churning but the market is rising. If this helps them, you might benefit from doing the same thing.

Technically, SPY is a no-load mutual fund that trades on the stock exchange like a stock. Investing in this stock is somewhat like buying the Vanguard 500 Index fund, but it is better for the purpose. Vanguard discourages people from buying and selling their fund like a stock. Almost all mutual fund managers want to minimize fluctuation in the amount of assets they are managing. That’s why most are so ardent in opposing attempts to “time the market” (an issue I may take up at another time). “Timers” sometimes sell their stock positions or mutual funds because doing so is required by their discipline for managing risk. Fund managers, on the other hand, have a vested interest in discouraging investors from doing anything that removes cash from the consolidated investment account they are managing. SPY, on the other hand, can be bought and sold like any other stock. Thus, if you get a buy signal on the market, but are not yet ready to take individual positions because of the number of breakdowns you are seeing in individual stock patterns, you might consider filling several of your portfolio slots with SPY. Then, as you need cash for the purchase of individual stocks, you can sell enough SPY to meet your needs. Because SPY represents 500 stocks, it is less risky than individual stocks in the early stages of an up-trend. This will enable you to participate on the upside even if individual stocks still lack stability. While you are waiting for good opportunities in individual stocks, you have the possibility of making much more than money market returns by investing in the market (S&P500) as a whole through the purchase of SPY. Even here, though, proper timing is essential. Do not invest in SPY until indicators confirm that the market is in an up-trend.

How can one know when to use SPY instead of individual stocks? The issue hinges on whether the new market trend has sufficient internal momentum to support individual stock trends long enough for them to be profitable. A simple way to monitor the development of a new market trend is to watch the Dow (tests conducted by our traders have convinced us that the Dow gives more precise signals for shifting trends in the market than does the S&P500). One way to approach the problem is to track the 10-day and 20-day simple moving averages of the Dow Jones Industrial Average. Your alert signal would occur when the 10-day moving average rises above the 20-day moving average. Your signal would occur when the 20-day moving average begins to rise while the 10-day moving average remains above the 20-day average. This alignment and the rising of the 20-day average would suggest that the momentum of the new trend is sufficiently developed to support trading in individual stocks. The position of the 10-day average above the 20-day average lets you know that the short-term trend still supports the rising of the 20-day average. Until these conditions occur, a person could stay with the SPY positions. Even after the signal is given, SPY would be sold off only as needed to free up money for a stock purchase. Reversing the configuration of these moving averages would provide a bearish indicator. Of course this combination of moving averages is only one example of the tools that might be employed. The purpose here is to be able to place money where it can earn a return well above that offered by any money market fund when individual stocks are whipsawing too much or triggering stop losses too frequently for most people to make significant headway toward profitability.