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As I reported earlier this week, the short-term LAMPP has turned red. It's only by a hair, but it did cross the line. This is no surprise to us. I have been reporting to you every week that we were getting closer and that a signal change was imminent.
I have been warning you that Treasury supply would soon increase radically. As expected, the federal government is now moving to raise the cash it needs to pay back the funds it raided internally under the debt ceiling and to rebuild cash. The Treasury will issue net new debt of $54 billion over the next few days.
At the same time, buyers of that new debt will no longer have the Fed's help in financing those purchases. In October, the Fed will start draining cash from the system, instead of adding $25-$30 billion per month to primary dealer accounts, as it has been doing lately.
The long-term LAMPP signal should turn red within the next month or so.
What that means is that the market should now begin its turn to the downside… the risk-reward equation has tipped to the sell side… and we will start seeing more and more opportunities to hop aboard the short side for solid profits.
Since you've hopefully been building a larger cash position over the past few weeks, you should be able to make one or more speculative trades to capitalize on the signal change. (Of course, timing these trades will require technical analysis, which I cover over at The Wall Street Examiner Pro Trader.)
But first things first – don't panic.
Don't Expect a Crash – Tops Take Time
There's no reason to panic. The stuff you see bandied about saying to sell everything because the market is about to crash is nonsense. Markets don't crash immediately after making a new high. When crashes occur at all in a bear market, they happen at least a couple of months after the peak. For example, in both the 1929 and 1987 crashes, the markets topped out two months before they crashed.
Likewise, the 2008 crash came in late 2008, well after the 2007 market top. There was plenty of time to get out as the 2007 top evolved over the second and third quarters of 2007. Maybe there's a first time for everything, but my technical work says this isn't one of them.
Unless you are following a good market-timing service like my proprietary Wall Street Examiner Pro Trader, I believe that a systematic selling program is the best approach under current circumstances. Without the guidance of technical analysis, averaging out is the way to go.
Of course bear markets sometimes involve crashes, but most of the time they are a series of ups and downs over many months. The typical bear market lasts from 24 to 30 months. Grinding, rotating losses kill portfolios. Interim rallies keep the public "hooked" into the market, hoping that each rally is the beginning of a new bull. But it's usually not until the third or fourth of those swings that a new bull market emerges. By then it's too late.
Some stocks take many years to recover. Others never recover at all. Even without a crash, the typical grinding, long-term bear markets have the same effect, especially for those investors who sell after it's too late. Then they fail to take advantage of those big bullish turns that always come when the Fed starts pumping liquidity into the system. They either don't want to because they no longer believe, or they have too little cash left to do any material buying.
Don't be one of those investors. If you have been raising cash, continue to do so. If you haven't started, there's no better time than now.
And it's also a good time to start dipping your toe into the waters of short selling, though it may be too early to buy puts. (Buying options requires pinpoint timing for success, and until the market has really signaled the start of the bearish trend, it will be tough to profit with puts.)
My Quick and Dirty Primer on Short Selling
More than just raising cash to ride out the storm and take advantage of the next buying opportunity, there are ways to surf those downhill waves for fun and profit. If you have been around the markets for a while, you know where I'm going here.
In a bear market, the pros profit by selling short individual stocks as well as both industry and market exchange-traded funds (ETFs). There are also inverse ETFs and leveraged inverse ETFs, which hold short positions in stocks, that enable market savvy traders to pile up tremendous profits when the market declines. We'll address those in another report.
The most sophisticated and market-savvy traders also buy puts on the market or individual stocks. Puts are essentially a bet that prices will fall below a stated price by a stated date. We'll also take a look at that strategy in another report.
With short selling, you can do just like the pros and profit from market declines.
But before you do, you must understand the risks. The most important of those risks is timing risk. Your timing must be very, very good indeed, or you will probably suffer losses, even though eventually the market will go your way.
To be profitable, these trades need to go your way virtually immediately. When they do, your profits can quickly pile up to multiples of your initial investment. Increased risk brings increased reward, when you are right about the market's direction and when your entry timing is good.
When you place an order to sell short a stock or a market ETF like the SPDR S&P 500 ETF Trust (NYSE Arca: SPY), which mimics the S&P 500, you are ordering your broker to sell a stock that the broker holds as collateral in its margin accounts. The broker sells the stock and credits the cash proceeds to you. At the same time, you become obligated to buy back the stock in the future and return it to your broker.
For example, if you sell short 100 shares of the SPY at a price of $250, your broker will sell those shares from its collateral accounts and credit your account for $25,000. You then owe the shares back to the broker at some undefined point in the future. However, there's theoretically no time limit on a short position. You could hold it forever if the price drops low enough.
Of course, if the SPY drops in price, at some point you will want to buy back the shares you sold and return them to your broker. Let's say the SPY drops to $200 and you buy the stock back to return it to your broker.
That type of order is called "buy to cover" because you are covering your obligation to return the shares. We say that you are "covering" your short.
At the price of $200 in this example, your cost is $20,000. But you originally sold the stock for $25,000. You have made a profit of $5,000. Here's where the leverage comes in. Your initial required margin on the short sale was just 50%, or $10,000. You have just earned a $5,000 profit on a $10,000 cash investment! And it probably only took a few weeks.
Let's look at another example.
About the Author
Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.