Once, Twice, Three Times a Bottom…

Time for another chapter in the saga of capital destruction we call the stock market.

Just in time for the negative GDP number everyone has been waiting for, the market is finding a bottom.  It may not be the ultimate bear market bottom, but it’s probably the bottom for 2008.  As we noted in We’re sure scared now…bringing it all together, “Historically, a retest of the lows develops within a few months to verify the strength of the bottom.  Hitting the exact lows again is not a necessity, but a second significant down move usually at least comes close.  This offers a great time to pick up relative strength leaders as they separate from the pack.”

We have seen not only one, but two tests of the lows since that writing, in the broad market indices.  Neither one of those tests completely reached the initial low, but both were violent and low enough to be considered valid.  The updated chart of the Dow Jones Industrial Average shows pullbacks of 1,500 and 1,100 points respectively, with both lows about 300 points above the initial low of October 10.

What has developed now is a trading range.  Not exactly bullish, but much better than the ski slope drop of the last few months, October in particular.  Seasonality is also about to turn positive as the November through April time period is historically the best six months of the year for the markets.  November itself is one of the best single months to be invested.

So how do we decide what to do?

There are several options here really.  Trading range strategies are particularly profitable in times of high volatility.  Selling premium and initiating spreads are some preferred options trading strategies for this kind of market environment.  For long term investors, picking up relative strength leaders near the lows is a great strategy.  Many stocks have been unfairly punished and are now wildly undervalued.  For indexers or 401k investors that have protected their assets with bond funds and stable value funds and cash, start moving it back in on these bad days as long as the lows hold.  For aggressive traders, we know there are some serious mean reversion trades already started.

What we must all keep in mind is that we do not know if the lows will hold or not.  As long as they do, buy them but don’t commit all of your capital at once.  Take little bites and dollar cost average into positions, especially if you are not trading.  There are many great opportunities here, but there will be many in the future also.  Don’t let yourself get stopped or margined out (heaven forbid) when you should be buying more.  The amount of forced liquidation by hedge funds is not something that is knowable by anyone.  It is creating great prices, but it could carry much further if the selling continues to feed upon itself.  If the trading range is broken to the upside we would become more bullish and would start to look at the 50 day, 200 day and 80 week moving averages as resistance.  Another bullish clue we are looking for is for volatility to drop, specifically the $VIX needs to drop under the 20 day moving average which has provided support since the breakout in early September.

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