Use ETFs to Protect Yourself From a Pullback

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Gillie

NEW YORK ( ETF Digest) -- Don't panic -- just be prepared.

Pullbacks are a healthy function of the market. They allow new investors to come into a rising market and signal profit-taking for smart money.

Timing a pullback and protecting your portfolio is of the utmost importance. What you don't want to do is sit and watch your portfolio's value sink. So, first let's look at timing a pullback.

Directional changes frequently occur at the intersection of trend lines as you can see in the chart below. The upper channel (green dashed line) intersected the long-term trend (blue dashed line) at the end of October, and the long-term trend line intersected with the mid channel (orange dashed line).

By projecting outward at the current trajectory, we see that the upper trend line (blue dashed) is about to intersect the lower channel line (red dashed) in the next few days.

A trend-line cross above the price is more predictable than a trend-line cross below the price. It is possible for this formation to result in an explosive move upward in price.

To anticipate better directional price movement at the intersection, we have to look deeper into present conditions.

During the first week of 2012, the price of the S&P 500 stalled at the price resistance level around 1280 (green horizontal line). We broke through this price resistance this past week but stalled again.

Friday's price action formed a hammer candlestick, typically a bullish formation. However, in this case, it's a red hammer, which often fails. Additionally, the tail of the candlestick pierced support, indicating weakness. Weakness was confirmed by the light volume. This gives us two bearish conditions on a bullish candle stick. Not encouraging.

Mid channel support/resistance (orange dashed line) is an often overlooked inflection point in technical analysis. We can anticipate the price of the S&P to hit this level around 1310.

That should also coincide with the intersection of the upper trend line and lower channel line as described above. Also, throw options expiration on Jan. 21 into the mix. Options expirations tend to throw the market into a tizzy. The middle of next week is likely an inflection point. OK, that covers timing.

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