Today (Martin Luther King Day) the US stock markets were closed, but the US futures market was open, as were foreign markets. The picture is fairly grim. Foreign markets are down 4% (Canada) to 7% (Paris). Stocks in Europe are now down more than 20% below 2007 highs, which meets technical definitions of a move into a bear market there. The pan-European Dow Jones Stoxx 600 index slid 5.4% on losses from Societe Generale, Allianz and other banks and insurance funds.

The global sell-off has been blamed on lukewarm reaction to President Bush’s stimulus plan announced last week, but the world’s markets have been cocked and primed for this as the credit crunch worsens and the extent of the subprime problem becomes clearer. Negative comments about subprime from a French banking official sent the Paris market down the most of all. They are now trying to erase his remarks, but the damage was done. This was Europe’s worst sell-off day since 9-11.

US futures were sharply down today, as well. Futures were down on the DJIA (520 points), S&P 500 (60 points) and Nasdaq (76 points). Whenever futures are down before the stock market opens, it usually heralds a down market day. Unless futures spike up tomorrow morning (and perhaps even if they do), there is a real likelihood of a further fall in the stock market.

For those who read the tea leaves, this is not good news. Major publications are using the “R” word pretty freely now, along with terms like “global free fall” and “global train wreck.” I don’t know if it’s as bad as all that, but it ain’t good. Things are going to get worse, much worse.

Let’s look at some charts:

The DOW closed at 12,099 on Friday, which is almost 15% below its 2007 high of 14,198 and well below August’s correction low of 12,517. We have a long way to go to reach the 20% mark off the 2007 high (11,358), which would be a technical signal we are in a bear market. The bear is, I have noted on prior occasions, snuffling his way our way. It’s only a matter of time. Is the time now? Maybe, but my money is on a snapback in the market and continuing the rolling pattern it has been in - if we don’t break sharply lower. In the chart below, note how the DOW has broken below its recent trading range, with two closes below the bottom trendline:

The sell off in recent weeks has occurred on increasing volume. The DOW is now testing the low of the Feb-March correction from 2007. Just doodling on the chart, below, I am wondering if we have not possibly seen a head-and-shoulders top to the market?

It looks kind of like a H&S, and the neckline falls rather classically, does it not? If the top was a head-and-shoulders formation, then the market has broken decisively below the neckline. Needless to say, a break (several closes) below the Feb-March correction low will be trouble. I think the old bull still has some legs left. At some point, traders and investors will decide that the market has sold off enough (for now) and buying will come roaring back in. The problem is, the big institutional players actually read and digest the financial news and its economic implications and are bearish. But the problem with going to cash is that so many places we would put our cash also are beset with subprime and similar problems in their asset mix. Hmmm, want to put your money in a bank? Better pick the right one…

What to do?

First, be watching the futures before the stock market open tomorrow, which MarketWatch.com usually covers. Although I rarely trade in the first 30 minutes of the day, be thinking about buying puts to cover long stock. I would consider buying ATM or near-the-money FEB puts on unprotected positions. If the market does not sell off or the sell-off is short lived, close the puts. A short-term bullish sign would be for the DOW to break higher back into (close in) the range it has been making. Even at 9-11, the market didn’t keep plunging, and it won’t this time, either. I will only buy puts tomorrow for the opportunity to profit on them if the market seems to be selling off again, because I expect the market to snap back.

Second, your future covered call writes should be SuperPut-protected. Those who wrote at higher price levels using the SuperPut strategy are not concerned with the market sell-off. Bluntly, it ain’t their problem. This is the way you should be trading. Limit your losses to a few percent of the trade debit, and soon make the trade completely riskless. This is the way to write covered calls, and you can do it all through the worst bear market. In fact, the dropping stock becomes your friend.

I’ll be giving out more information soon about my SuperPut strategy and our new SuperPut lists, so keep watching. A bear market is to be feared only by those who aren’t protecting their stocks properly.

This entry was posted on Monday, January 21st, 2008 at 6:39 pm and is filed under Markets/Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.