Wait

I've received a number of emails from ECAM subscribers over the past 2 days worried about whether they should be selling at this point into this decline.

I am currently in Toronto and unable to do a video update (which most subscribers appear to prefer) so will use the standard written format.

I empathize with these reactionary views I've received as these are very frightening times indeed in the markets.  However, far from panicking, it is times like these where in the past where I have made my greatest gains.  Alternately, it is times like these where in the past I have protected my greatest potential losses.  The human nature to flee is essential and knowing when to move is paramount.

I hope to put some context to where we are currently at in this blog along with what you may want to do with your portfolios (as always, please refer to the legal disclaimer below as I am required to publish by law).

Successful investment in equities/commodities/currencies/etc requires the ability to identify the probabilities of any given scenario.  Those that can identify market conditions where the probabilities of an investment vehicle going up in price exceed the probability that the same investment vehicle will go down in price are the ones that ultimately succeed in the investment game.  Technical analysis offers us the opportunity to quantify the potential success of any such prediction of probabilities.  I hope to use the following example today as a case in point.

We have had a rapid and brutal decline in the worlds equity markets over the past 2 weeks.  In fact, the rate of decline is unprecedented and has set numerous records for number of consecutive days down and daily point ranges (volatility).  There is real fear in the markets and amongst investors as to where this all might end up.  However, as I have stated numerous times, it is times like this I turn off CNBC and the talking heads and concentrate on the technicals.

CLICK ON ALL CHARTS TO ENLARGE

1)  History Making Event

The rate of decline over the past 2 weeks has been severe.  Given such, I went back and looked at all instances over the past 30 years where we had the same conditions:

1)  in an uptrend (as defined by the slope of the 200 day moving average being in an uptrend)

2)  daily price breaking below the 200 day SMA, and

3)  daily price closing 3 standard deviations below the 200 day SMA

SPX 1980-2011

As I have noted on the chart, over the past 30 years there have only been 3 such events; 1987, 1990 (both boxed in blue) and today (boxed in red).  This tells you how unusual this current event is.

2) 1987

SPX 1987 Decline

The market crash in 1987 is the best example of a previous market decline that matches our current levels.

As can be seen, the market was in a well established uptrend (as defined by being above the 200 day SMA in the dotted black line) that drastically broke down below 3 standard deviations below the 200 day SMA(as shown as the solid black line).

The day following the breakdown was defined by a "lower low" inter-day (the tail extending below the dotted black line) but by the days close price was back above the line.  At that point, price attempted 2 retests of the closing lows (one within a few days and another 1 month later) followed by rangebound trade.

Eventually price resumed its uptrend and new highs were eventually made in the months ahead with price once again moving above the 200 day SMA 7 months later.

3)  1990

SPX 1990 Decline

The decline in 1990 was similar as price broke below an up trending 200 day SMA.  Price once again closed below the 3 standard deviation line below the 200 day SMA (solid black line on the chart).  Price once again popped back above the 3 standard deviation line on day 2.

Where things were different on this decline was price broke below the 1st close to challenge the 3 standard deviation line a second time one month later.  That second low became the ultimate bottom and price began a very rapid advance that broke above the 200 day SMA 3 months later.

4)  2011

SPX  2011 Decline

Our current decline is shown above.  Once again, as can be seen, we broke below the 3 standard deviation line (solid black line) and regained the line on the second day.

What is interesting is price rose strongly up on day 2, strongly down on day 3 (testing the previous closing low) and strongly up today.  This indicates the incredible volatility currently in the market (market moves of 4-5% per day are unheard of).

Are we 1987 or are we 1990 or are we something new?  That is the question that will make you a fortune or save you a fortune.

In 1987 we never closed below the closing low (defined by the breaking of the 3 std deviation level).  In 1990 we closed below the previous closing low but we never closed below the 3 std deviation level a second time.  This clearly defines our trading strategy.

In the next few days if price:

1)  Closes below the previous close of 1120 AND the 3 std deviation level-  SELL

2)  Closes between the low of 1120 and the high of 1173-  HOLD CURRENT

3)  Closes above the current range above 1173-  BUY

I hope this gives an example as to how clear cut technical analysis decisions can make complex investment decisions.

Whether ultimately the above results in profit is unknown as technical analysis is not a crystal ball (as is investment in all risk assets).  What the above does do is put the probability of future market direction firmly into view (based upon historical precedent) at times where the market does not appear to have any clear "order".  This allows me to clearly define my risk/reward and to clearly define where I have been "right" as defined by future market direction (and to stay with the trend) and where I have been "wrong" as defined by future market direction (and to sell current positions).

Only the market will ultimately tell us where it wants to go.  We merely need to listen to what it is saying and react accordingly.

Emirates Provident Fund:

As of Friday, 11 August 2011 I remain in a strategic 50% equities/50% USD cash weighting as follows:**


-BlackRock US Dollar Cash Portfolio Fund: 50%

-Russell Global 90 Fund: 15%

-Fidelity International Fund: 10%

-BlackRock Managed Equity Fund: 25%


**Actual positions will change daily based upon price action and market volatility.

Legal Disclaimer: The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions. NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES. The author will reveal his current market positions and holdings but actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility. The author is not licensed as an investment advisor in the UAE and therefore cannot provide individual account advice to individuals and/or institutions.

For further information please use the following email address and I will do my best to get back to you when able.

ecamquestions@gmail.com