The best thing to do when the stock market makes a huge one day ramp up on questionable volume after overnight futures were bid way up in my view is to remember that GAPS GET FILLED.
While value investing is my personal bend, I have come to respect technical analysis because that’s what most pros use to trade equities and commodities. Right now, the gap on the SPY chart after the “Cliff Deal” means that stocks are precariously vulnerable to a large 5% or so sell off sometime in the next two weeks. My suggestion is to buy some type of protection either via IWM in the money put options or through the selling of front month call options on your liquid large cap stocks.
Gaps almost always get filled because many times traders with huge books and inside info simply bid up a market before major news (like a Cliff Deal) gets released. Once the news is out, the quick drop or run-up usually reverses and the gap in the chart gets filled, the traders who have friends in Congress are already out and the little guy who bought the hope sells out at a loss. Once this cycle is complete, the strong hands in the market return to rinse and repeat.
Right now, Hedgephone is suggesting investors short the IWM against their small cap long positions but only if they own 15 or more equities in a diversified portfolio. For investors with a more speculative bend, shorting the IWM via put options makes a lot of sense, but heed the January effect and remember that the short run may wipe out some short equity — it’s okay to dollar cost average into your shorts as well as your longs!
While CRM is certainly proving us wrong at hedgephone in the short run, the valuation bubble persists. IWM is similar (though it actually has real earnings) in that valuations are disconnected somewhat from reality. Don’t get caught up in the liquidity trap and buy based on fear of missing out. The rally from the 2009 lows has been remarkable, but investors should buy solid companies that have fallen not those stocks which have risen the fastest in the least amount of time. Value investing is about mitigating risk and optimizing reward so buying when their is blood in the streets is key. Right now, with the VIX at a major low, it’s time to play defense and to protect the capital you have earned since the 2009 lows. A bird in the hand….