Wednesday, November 19, 2008

Stock Trading Ideas after Stock Market Drop Today

The S&P 500 went down 52.54 points today, to close at 806.58, a drop of 6.12%.

The S&P 500 broke below previous support of around 839 and 818.

We previously wrote what could happen if the S&P 500 breaks below 839, or even if the S&P 500 breaks 768.

This can be a very scary market, but for traders, this can be a great market. Traders like volatility. For many years, the US Stock Market had been trading at below average volatility, and it was just a matter of time before the stock market reversed itself and entered a high volatility phase. We are currently experiencing this high volatility.

Using SPY as Trading Vehicle

One trading vehicle is to go long (profit when stock goes up in price) or short (profit when stock goes down in price) the SPY, the S&P 500 ETF

The SPY attempts to mimic the S&P 500 index, but it is not a perfect match. In general, the SPY is currently at $81.50, and the S&P 500 ($SPX) is at 806.58, an approximate ratio of 1 to 10.

Using Inverse ETFs to Trade

Alternatively, you can use the inverse ETFs at

Some of the products include:
  1. SH: ETF that goes up 1x if the S&P 500 goes down 1x, and ETF that goes down 1x if the S&P 500 goes up 1x.
  2. SDS: ETF that goes up 2x if the S&P 500 goes down 2x, and ETF that goes down 2x if the S&P 500 goes up 2x.

So rather than shorting the SPY, you can go long on the SH. Of course, the behavior and value of SH differ from SPY.

Trading Ideas After Stock Market Drop Today

The S&P 500 broke below previous support of 839 and 818 (on an intraday basis), and it appears as if we are in a breakdown and the SPY is trying to find a trading range.

We expect the upper band of the trading range to be previous support at around 839. It is known that what was once support now becomes resistance.

On the downside, it appears that 768 appears to be the next major bottom. This 768 bottom was reached October 10, 2002, 6 years ago, in a major bottom after the 2000-2002 Bear Market.

So if the S&P 500 ever reaches 768, we do not expect it to break through 768 right away. It should respect the 768 major support at least once.

So how can we formulate a possible trading plan?

A) First Trading Idea: Short SPY here

This plan refers to trade A) in the chart above.

We know upper resistance on SPY is around $83.50. And since the SPY recently broke down below this (ideally, with high volume), the short term trend appears to be down. In fact, it is possible that the SPY can shortly re-test resistance at $83.50 before continuing down.

The first trading idea is to short the SPY (or go long on the SH), around these levels.

Where is a possible bottom?

As we discussed earlier, $76.80 is a good target on the downside, and a single re-test of the October 10, 2002 lows should be in order. This is a major bottom.

We can cover the short near this area.

B) Second Trading Idea: Go Long SPY at $76.80

Since we expect at least a single re-test of the $76.80 levels, we can cover our previous short, and then go long SPY.

Where can we cover? We do not know how far the rally can last, but the resistance area of $81.80 to $83.90 area would be good bets.

C) Third Trading Idea: Short SPY after rally to $82

Once the rally runs out of steam, we can sell our previous SPY long position, and go short for the estimated re-test of the SPY low of $76.80.

We do not know whether the re-test at $76.80 will succeed or not, so it is best to cover the short around this area.

D) Fourth Trading Idea: If SPY breaks $76.80 to the downside, Short SPY!

If the SPY finally breaks the major support of $76.80 to the downside, it is time to short SPY because this would be a very bad scenario for the market, but an opportunity for you to profit.

Use Limit Orders, Stop Orders and Trailing Stops

This is a very fast moving market. If you cannot monitor the stocks every moment of the day, you can use limit orders, stop orders and trailing stops.

Today SPY is at $81.50. Let's say during this time, you put in a Limit Order to Buy at $76.80 (good for 60 days).

SPY starts going down (your order has not been executed at this time) but has not reached $76.80. Then several days from now, SPY reaches $76.80.

After purchasing SPY at $76.80, you then put in a Stop Order to Sell at $75. You expect SPY to bounce at $76.80 and go higher. If this happens, this is good, and you eventually take your profit.

But there are times when you are wrong. SPY could continue falling below $76.80 and when it hits $75, your SPY order to Sell will be active.

Is it possible that SPY reaches $75, hit your stop order to sell, then start climbing upwards again? Yes, this can happen. But it is good to remain disciplined, and stick to the rules.

You can also use Trailing Stops as a technique to limit losses, and to protect profits.

Let us Monitor the Situation

Of course, we should monitor the situation at each stage, and we should remain disciplined.

Today's SPY Chart

Today's S&P 500 Chart ($SPX)

1 comment:

stock trading newsletter said...

Some great ideas that we can still use today.