Dow Futures Reach New Lows Overnight

The Dow Index futures have reached new lows for 2008 (and the current bear market) overnight. This chart shows the overnight chart for the Dow. It has since recovered nearly to the flat line this morning. It's anyone's guess what the day session will look like later this morning.

I feel sorry for those who have held onto their stocks and indexes over the last six months, because the stock index futures have reached new lows for the year overnight. However, if anyone has continued to hold onto their positions through all the bad news since the beginning of the year and through all the warnings of recession, they are either foolish or have a very long-term perspective that will perhaps permit them to ride out the recession (I'm trying to be kind, here). Profits aren't profits unless you take them! Look at the daily chart of the Dow Index futures below. Does that look (below) like a bottom to you? It's been moving steadily downward since May 20th!

(Interestingly, to be intellectually honest, a lower close inside the purple Bollinger Bands as shown on this chart is a sign of waning downward momentum, so perhaps a bottom is not far distant, at least for now. The Klinger Volume indicator is also signaling a shift in momentum. There are some signs that the stock indexes are trying to form a bottom, so there is some hope. But I sure wouldn't bet on it, especially since markets can often re-accelerate downward later. With earnings season just beginning and P/E ratios very rich based upon a healthier economy from past quarters, I won't be surprised if a few disappointments lead the markets still lower as those rich P/E ratios force the markets lower to compensate. But that just an opinion, not a prediction.)

Sometimes investors are deceived by advisers who claim to have their best interest at heart, telling them to ride out bear markets, saying that since the market has declined so much, therefore we must be close to a bottom. These people don't know how to analyze charts, so they advise their clients to just hold on for the ride. I suppose that misery still loves company.

This idea that markets have declined and now must turn higher is pure fallacy. Just because a security or other financial instrument has declined substantially does not mean that it therefore must now turn higher. Wrong! Have you ever heard of Newton's First Law of Motion in physics, also known as the law of inertia, that states that "objects in motion tend to stay in motion" unless acted upon by an unbalanced force?

This principle is also taught by Chick Goslin in his book "Trading Day By Day", and also applies to the financial markets. Financial trends in motion also tend to stay in motion -- unless some other powerful countervailing force intervenes. Prices that have declined substantially can decline still further. In fact, stocks can go to zero. (Commodities don't. They always eventually find a bottom and retain value. I guess that means I'm biased.) The larger the market, the longer the trend tends to remain in motion. It takes a great deal of energy to change or shift momentum toward the opposing direction.

Wouldn't it be much wiser to exit the market or a stock, wait until the bottom forms a solid base, and buy again after the market begins to head higher at a much lower price, thereby assuring an investor of a greater profit after buying at a lower price later? This is why I always use tight stops, as recommended by Phantom of the Pits in his book, "Phantom's Gift". Who's to say that the stock market that has now declined 20% won't decline an additional 20% -- or more -- before a bottom is formed?

Recall that the NASDAQ is still only about 50% off its former high. NASDAQ investors with a buy-and-hold philosophy are still waiting for the index to recover to its former all-time high -- and they'll continue to wait!

Returning to my previous example of a 40% decline, a Dow investor that holds onto his/her position through the entire 40% decline would have to earn a 66% return off the bottom in order to get back to the same level they reached at the market top. (A 40% decline leaves an investor with 60% of the amount they had at the top. It requires a 66% return -- 40%/60%=66% return -- on the remaining 60% to get back to the quantity that the investor once had at the high. That's a very deep hole to dig oneself out of!) In the case of the NASDAQ that declined by 50% off its high, an investor would have to earn a 100% return just to get back to their former equity value. Another very deep hole!

Better yet, instead of exiting the market and waiting for re-entry, wouldn't it have been better still to have been short the stock market over the past several weeks? Note the fantastic uptrend on the daily chart of the ETF that shorts the S&P 500 index, which has been trending solidly higher since mid/late May. While "buy-and-hold" investors were losing money day by day, swing traders have been profiting from the economic downturn by buying this ETF (see chart below, ticker=SDS).

Meanwhile, swing traders who ride the highs and lows of the markets, moving in and out, buying and selling the waves of activity, are earning a return while investors are sweating bullets and trying to survive sleepless nights. One can learn to trade, or one can endure sleepless nights!

In my IRA (using no leverage) using ETFs, I exited my stock indexes nearly 9 months ago. I went short in January, making a solid return on the sharp decline in the first weeks of 2008. I then went long through part of the Spring months primarily in foreign stock indexes and energy ETFs, once again going short late May 08. I did all this by reading the technical analysis charts. While many investors are wringing their hands, hardly able to sleep nights, hoping that the stock market will bottom out or that the government or Fed will engineer a bail-out that will have some muscle, I have been fortunate to have increased my IRA more than 35% year-to-date.

Buy-and-hold strategies are for people who are incompetent at technical analysis. Again, misery loves company. Everyone should learn how to read the charts and recognize turning points in the markets so they will know when to get out of the market near (note that I did not say at) tops, and get into the markets after they have bottomed and begin to turn upward again.

I have heard an investment idea that is attributed to one of the Rothschilds (sorry, I don't know which one) that they enter the market after the first 20% of a move, and they get out before the last 20% of the move. They don't get greedy by trying to pick tops and bottoms. No one has ever been able to do that consistently. But we can learn to recognize an emerging trend after it starts and take advantage of it. We must likewise also learn to recognize when trend momentum is waning so that we can exit in a timely manner. That is what I strive to achieve.