The markets remain in an extremely volatile state, with the
Dow Jones Industrial Average
regularly making triple-digit moves and the
up more than 5.5% since the mid-July low.
The move in the S&P was just enough to suck investors' money in from the sidelines before a sharp turn lower last week. This is a normal characteristic of a bear market, where explosive rallies take place within a downtrend. That pulls in unsuspecting investors who are trying to pick a bottom in the market.
Although some of my indicators are improving, especially in the small-cap area, I don't think we've seen the end of the primary downtrend. Whether we are near a bottom, no one really knows, but the market will certainly give us clues with new leadership.
The key point to remember is that the financial markets are made up of a large mass of people all driven by the same essential needs. When stocks move excessively in one direction, people tend to exhibit four basic characteristics -- fear, greed, hope and panic.
The only way to control these emotions is by using a predetermined investment plan along with proper money- and risk-management. That means having a systematic plan to start acquiring a position and taking profits.
This week, I'm going to cover two exchange-traded funds that are seeing these types of extreme moves and discuss the proper way to manage a position in them.
To begin, we will look at a momentum move in the
. In late June, the price broke strongly above the 200-day moving average on solid volume. Although that was a nice move, it still happened within a year-long base.
That all changed in July, when the price went into a parabolic rise on extremely heavy volume. That move has certainly been supported by the recent strength in many of the biotech stocks, which obviously draws in the momentum players. The problem is the slightest weakness in the shares will send the momentum money running -- and that can cause a very sharp correction, especially when the shares are so far extended from their moving averages.
If you have a profit-taking plan in place, you can lock in gains as the stock or fund continues to move up. I do this by taking one-third of my profits once a position has moved up 20% to 25%. Then I will follow the stock up with trailing stop losses under short-term support areas with another one-third of my position. This way, if I get stopped out and the stock reverses back up, I still have a position.
Now, the volume is quickly declining, showing that the move higher is starting to lose steam. That doesn't mean the fund is in for an immediate drop, but it is a warning signal of possible weakness to come.
On the other end of the spectrum is the
US Natural Gas
ETF, a fund that has gone into a parabolic decline. This example reveals just how fast gains can vanish without profit-taking and protective sell-stops on the way up.
This fund has retraced almost 100% of its prior move since February. That's something that does not happen very often, especially over a four-week period. From a technical perspective the risk of a further decline is likely limited, and the price should find some support between the December lows and the January highs.
In these situations, I certainly don't advise trying to catch a falling knife, because bottoms can take time to form. Also, when a stock or fund falls off of a cliff like this it often takes quite a bit of time before it's able to regain its strength. That said, traders can look to play a bounce above short-term resistance levels, such as the current one drawn on the chart. The key is to exit the trade as soon as weakness reappears.
At time of publication, Manning had no positions in securities mentioned, although holdings can change at any time.
Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Manning appreciates your feedback;
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