It's Time to Consider Portfolio Insurance

NEW YORK (TheStreet) -- The reason people buy auto and home insurance before they find out they will need it is because by the time you find out you need insurance, the damage is already done. If you've ever been involved in a car accident, you know you can't add coverage when it becomes obvious you're about to crash.

The same is true with the stock market. You never know when the market is about to have a correction or an outright crash. For most investors, including those on Wall Street, there's never enough notice to adjust after the fact.

As you can with your home and auto, you can buy portfolio insurance -- and the best part about the market is you can time it to when you are most at risk.

The market provides us warning signs when a correction is more likely than normal. Some are emotional; for example, when people who never talk about stocks begin letting everyone in the neighborhood know about how much money they're making, that's a sign.

Another emotional sign comes from self-reflection. If you're feeling like you should "juice" your returns by using more margin at a time when record amounts of margin is used (which is the case right now), that's a sign.

When stock valuations reach well outside historical norms, especially in relation to earnings, that's another sign. Another is when JPMorgan Chase (JPM) analysts start giving $300+ price targets for automakers that are unprofitable based on projected earnings six years from now from factories that are in the planning stage, that's a sign. (If you're unsure what company, it's Tesla (TSLA).)

Regardless if you own Tesla or any other stock, you're likely diversified in your holdings. An overall market drop will have an impact on you but maybe you still don't want to sell. There is a whole list of reasons why you may not want to exit any given stock or all of them.

Maybe you have tax considerations, or maybe you're a long-term holder and overall market direction is not a catalyst for selling. Maybe you're retired and collecting dividends and don't want or can't find an alternative investment. At the same time, you may want to lock in some gains without removing your upside potential.

The SPDR S&P 500 ETF (SPY) is based on futures that are, in turn, based on a basket of the 500 most influential publicly traded companies. You may see the Dow Jones Industrial Average reported on your nightly news, but for Wall Street, the S&P 500 is what traders pay attention to.

One of the tools I use to project and time the overall market is a variation of legendary Tom DeMark's indicators. I've made my own adjustments and alterations based on back testing and optimization, but the final setup still uses a 13 in a series of higher highs to alert the market may be extended and ready for a correction.

In my chart, I circled two weekly bars that are 13s. The first occurred in the middle of May. Had you shorted the SPY the following week when the market exceeded the high's on the 13, you would have quickly realized a gain. From peak the following week to the bottom six weeks later, the SPY dropped about 12 points, or about 7%.

Last week, the chart produced another 13. Is this cause for alarm, and is the market about to crash? No, it's not a crystal ball and alone, is only one indication. However, it becomes much more compelling when two or more time frames generate the same. This is where things become more intriguing.

SPY Weekly Chart

Courtesy of TradeStation


This chart is the SPY monthly chart. In this case, you don't see it, but this month is currently a 12. The 200 period moving average is so far below our current price that it doesn't even show (it currently has a value of $123).

Again, not a crystal ball, but we don't need to predict the future, only the odds. For me, there is enough of an edge going short that I believe it's worthwhile for investors to pick up portfolio insurance if you don't already. I'll explain what that is in a moment, but let's look at one more SPY chart, the daily bars.

Courtesy of TradeStation

At the time of writing, the day isn't finished yet, but currently will register a 13 on the daily at the end of day (unless the market falls significantly before the close).

When I see the daily and the weekly enter an extended area at the same time, I consider the odds have shifted, albeit slightly, into the short thesis camp. The move higher may not be finished, and may continue higher. But I now have enough reason to buy protective puts. Which is what I did on Thursday.

I posted my trade idea in Real Money Pro. Take a look (and if you don't have a subscription, no problem, you can read with a free trial).

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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