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Bear Market Behaviors
Author: Bob Lang (info)
Website: http://trade-mentor.com
Posted: February 8th, 2008 at 9:20 am EST
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It seems pretty clear we have entered a bear market. Whatever the reason you want to use…subprime mess, housing issues, slowing growth, banking/broker lending problems, weak dollar, overseas panic….it seems pretty evident we’re in bear territory.
If you don’t believe me, look no further than January’s horrible market performance - the worst in decades. Couple that with a strong showing from bonds (yields dropped sharply) and you see that risk aversion is the play these days.
A Lonely Place
We haven’t seen much of a bear market for a few years. The last one lasted about three years, and it was as nasty as ever. Of course, it followed a huge market run in the 90’s that saw record runs eclipsed day after day. The selling was intense in those days. There weren’t many who called it in 2000, but our Chief Analyst (Price Headley) nailed it back then (and was recognized by Barron’s).
Why do I bring this up? The bear camp is a not familiar one to most people. In fact, it’s a very lonely place, for obvious reasons (coincidentally, the Bigtrends Market Timer just went bearish on Feb 1…very timely).
Who wants to admit the markets are heading lower, even if it is the truth? Better yet, who wants to listen to that? Most people are invested long in the markets and don’t want to see it go down and lose wealth. Behavior is quite different during a bear market. In fact, the fear permeates and results in sharp drops in equity…that has the effect of yelling fire in a crowded theatre.
Charting the Waters
From a technical perspective, one action reins supreme in a bear market: FADE THE RALLIES. This approach wins more often than the bull market mantra of BUY THE DIPS. But, how do we know to fade the rallies? Better yet…what type of signal tells us to?
One of the more reliable indicators I use is a 20 MA Bollinger bands with two standard deviations around the average. In a bear phase, few if any stocks will pull over the top band for any length of time, and will gyrate between the bands. In a higher volatility environment such as now, we’ll see bands widen as prices move within sizeable ranges. It’s not unusual to see the bands expand 2-3 times normal width…remember, the wider the bands, the wider the price range. I’ve found that buying puts or shorting when a stock is at the TOP of the range works well in a choppy or bearish environment.
When to sell or cover the short is determined by risk/reward parameters, but halfway down the channel (or, to the 20 MA) works well to take partial profits, with a move down to the lower band the ultimate objective.
An example of such a trade is below with a recent put play on LEH. We bought the front-month at-the-money puts when the stock was at the top of the Bollinger band. You can see that on six different occasions that was a call for lower prices, and in a wide range (12-14 points top to bottom) that the rewards are handsome. At this writing, we currently hold the puts in the Grandslam portfolio, bought Jan 31.
Bottom Line….Caution
I’m not completely bearish here, and you shouldn’t be either. The Fed is there supporting the market in some fashion, so there will always be some value buying because of it. The landscape has changed, however…and we must adjust accordingly.
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Bob Lang, Indexes
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2 Responses to “Bear Market Behaviors”
February 8th, 2008 at 8:22 pm
Nice evaluation of the present condition of the stock market.
I totally agree with you and believe the indexes will get into a minimum of 6 months to perhaps as much as 2 years into a downtrend.
My objective right now is the DOW is down around 10,000 and in the NASDAQ around 2000. Whether that is the ultimate objective or just a mid-term objective it is too early to tell.
I do not see any strong rallies occurring at present.
February 11th, 2008 at 9:21 pm
It seems evident that the bulls will try to make a stand in the indexes tomorrow as they were successful today is turning the market around intra-day and closing it near the highs.
The bulls have their backs against the wall and with the asian markets closed today and tomorrow, what better time to try to rally the indexes.
It is very likely the indexes will rally tomorrow but just how high they rally will be the question in everyone’s mind. That piece of information will be gathered by the bears to determine just how much strength the bulls have left.
There are three levels to watch in the DOW on a daily closing basis. The first one is 12319, the second one is 12379, and the last one is 12481. These three levels still mean the DOW is in a downtrend but the higher the closes are the less weakness exists.
The DOW literally has to close above 12481 to generate any confidence among the bulls, and it needs a close above 12800 to make the bears take notice.
I don’t think it will be able to do that, so the question remains “are the indexes ready to continue the downtrend or are they simply pausing in a sideways fashion until the results of the FOMC meeting in the last week of the month comes out.
Personally, I think the indexes will continue to slide down, but do it slowly at this time. I think the DOW will get down to 11940 before the end of the week but close around the 12000 level.
My opinion.